Ngân hàng, tín dụng - Chapter 18: Bank reserves and the money supply
Very important asymmetry in the creation or
contraction of reserves/money supply
– When banks have deficient reserves, they must reduce their
demand deposits which reduces the money supply
– When banks have excess reserves, they may lend more and
increase the money supply.
– Usually assume banks will want to lend out all their excess
reserves and expand demand deposits to the maximum
because they earn interest on the loans
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1Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Chapter 18
Bank
Reserves and
the Money
Supply
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-2
Learning Objectives
• Understand the mechanics of check clearing and
its impact on the balance sheets of commercial
banks and the Federal Reserve
• Explain how banks create deposits by making
loans
• Define the role of the banking system in deposit
creation and destruction
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-3
Introduction
• Examine the relationship between bank reserves and the
money supply
• Money supply (M1) is composed mostly of demand
deposits in commercial banks and other financial
institutions
• Bank reserves play a crucial role in creating demand
deposits
• By regulating bank reserves, Federal reserve gets
leverage to control amount of demand deposits and
thereby nation’s money supply
2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-4
Check Clearing and Collection
• Focus on the relationship between reserves and
demand deposits
• Demand deposit is an asset for the depositor, but
a liability of a bank because it is obligated to
pay it on demand
• Federal Reserve has little direct contact with the
public, mainly deal with the government and
financial institutions
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-5
Check Clearing and Collection
(Cont.)
• Federal Reserve is primary collection vehicle for
checks
• Check clearing is accomplished by adding or
subtracting reserves held on deposit by the bank
at its regional Federal Reserve bank
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-6
Check Clearing and Collection
(Cont.)
• Sequence of events when a check, drawn on the other
bank (B), is deposited in our bank (A)
– Demand deposits in Bank A increase with a corresponding
increase in assets (check in process of collection)
– When the check clears through the Fed check clearing
system, the Fed increases Bank A’s “deposits in Fed” by the
amount of the check
– There is a corresponding decrease in the deposits of Bank B
which is made by the Fed
3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-7
Check Clearing and Collection
(Cont.)
• Sequence of events (Cont.)
– Demand deposits in Bank B decrease when the check clears
– Therefore, the Federal Reserve neither gains or loses deposits,
only transfers ownership from one bank to another
– Summary
• When a bank receives a check drawn on another bank, it gains
reserves equal to the amount of the check
• The bank on which the check was drawn loses reserves of the
same amount
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-8
Check Clearing and Collection
(Cont.)
• The above sequence of events occur whether the
banks are members of the Federal Reserve
system or not
• If the banks are in different Federal Reserve
regions, the two regional banks have a clearing
account which permits the transfer of reserves
between regions
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-9
Check Clearing and Collection
(Cont.)
• The balance sheet of Bank A (as shown in the text)
reflects the following changes:
– Demand deposits have increased by $2,000,000
– Deposits in Fed (reserves) have increased by $2,000,000
– Bank A’s total reserves now equal $3,000,000 ($100,000
cash, plus $2,900,000 deposit in Fed)
– Since the bank is required to hold 10% of demand deposits as
required reserves, Bank A’s excess reserves now total
$2,800,000 ($3,000,000 - $200,000)
4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-10
Deposit Expansion: The Single Bank
• How much a bank safely can loan depends on:
– Amount of excess reserves
– What happens when a loan is made
• When a bank lends, the borrower receives a checking
account (demand deposit)
– Both sides of balance rise, increase in “demand deposits”
(liability) and increase in “loans” (asset)
– Since demand deposits are part of the money supply, when
banks create demand deposits through lending, there is an
increase in the money supply
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-11
Deposit Expansion: The Single Bank
(Cont.)
• A bank can safely lend up to the amount of its excess
reserves
– When proceeds of the loan are withdrawn and the reserves are
reduced by the amount of the check, all the excess reserves
will be used up.
– If the bank tries to lend more, there will be insufficient
reserves as soon as the borrower withdraws the proceeds from
the loan.
• If the bank purchases government securities equal to
the amount of excess reserves, it loses excess reserves
when its check clears
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-12
Deposit Expansion: The Single Bank
(Cont.)
• Conclusion of the section
– A single bank can safely lend (or purchase
securities) up to an amount equal to its excess
reserves
– An individual bank can create money (demand
deposits) only if it has excess reserves.
– As soon as it creates this money, it loses it to
another bank when the money is spent
5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-13
Deposit Expansion: The Banking
System
• Although the initial bank lost its excess reserves,
another bank gained these excess reserves which
permits them to expand their lending and increase
the money supply
• However, ability of the next bank to extend loans is
reduced by 10% since some of gain in reserves must be
held on deposit with Fed
• Process will continue with each successive bank being
able to lend only 90% of gained excess reserves and
10% placed on deposit with Fed
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-14
Deposit Expansion: The Banking
System (Cont.)
• Banking system creating money
– The banking system will have demand deposits that are a
multiple of the initial injection of excess reserves into the
system.
– The Fed will have additional required reserves on deposit
equal to the initial injection of excess reserves into the system
– The final state is reached not by shrinking reserves, as in the
case of a single bank, but by expanding deposits
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-15
Deposit Expansion: The Banking
System (Cont.)
• Banking system creating money (Cont.)
– When one bank loses reserves, another bank gains the excess
and lends out 90%
– As banks lend more and more, demand deposit liabilities
grow, thereby reducing excess reserves
– Whereas a single bank can lend the amount of excess
reserves, banking system can create demand deposits up to a
multiple of original change in reserves
– The process of deposit expansion can continue until all excess
reserves become require reserves because of growth of
demand deposits
6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-16
RatioserveRe
xservesReExcess=DepositsDemand
1ΔΔ
RatioserveRe
1
Deposit Expansion: The Banking
System (Cont.)
• The demand deposit expansion simple
multiplier is always the reciprocal of the
reserve requirement ratio
Where: is the simple multiplier
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-17
Deposit Contraction
• If a bank starts with deficient reserves, potential
change in demand deposits is negative rather
than positive
• Money is destroyed as bank loans are repaid or
securities sold
• The potential multiple contraction in demand
deposits (money supply) follows the same
principles as expansion of demand deposits
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-18
Deposit Contraction (Cont.)
• Downward multiple change in demand deposits
could conceivably take place in one single bank,
but more likely would be a result of action by
entire banking system trying to acquire reserves
to make up for the deficiency
7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-19
Deposit Contraction (Cont.)
• Very important asymmetry in the creation or
contraction of reserves/money supply
– When banks have deficient reserves, they must reduce their
demand deposits which reduces the money supply
– When banks have excess reserves, they may lend more and
increase the money supply.
– Usually assume banks will want to lend out all their excess
reserves and expand demand deposits to the maximum
because they earn interest on the loans.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.
Appendix
THE COMPLETE
MONEY SUPPLY
PROCESS
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-21
Appendix—The Complete Money
Supply Process
• Actual change in demand deposits will reach the
maximum amount indicated by the simple multiplier if
banks lend all excess reserves.
• Any leakages of cash out of the multiple expansion
cycle will result in a smaller expansion of the money
supply
• Federal Reserve can control additional excess reserves
but leakages are outside their control and may
adversely affect their attempt to expand the money
supply
8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-22
Appendix—The Complete Money
Supply Process (Cont.)
• Shifts between Currency and Checking Deposits
– Monetary base (B)—total reserves held by banks plus
currency held by nonbanking public
– When the Federal Reserve injects reserves, it is really adding
to the monetary base
– Public may elect to hold some of the excess reserves as cash
instead of demand deposits
– Figure 18A.1 shows this ratio varies over time
– Draining of currency into the hands of the public depletes
bank’s excess reserves
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-23
FIGURE 18A.1 The currency ratio (c/dd)
has varied considerably over time.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-24
Appendix—The Complete Money
Supply Process (Cont.)
• Shifts between Currency and Checking Deposits
(Cont.)
– Although cash held by the nonbanking public becomes part of
the money supply, it reduces the banking system’s ability
to expand demand deposits
– Due to the uncertainty of the public’s reaction to additional
reserves and desire to hold cash, the Fed has more control
over the monetary base than total reserves
9Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-25
Appendix—The Complete Money
Supply Process (Cont.)
• Shifts between time deposits and checking
accounts
– The public may desire to hold time deposits rather
than demand deposits
– Since the required reserves for time deposits is
smaller than for demand deposits, placing of funds in
time deposits will increase the banking system’s
ability to expand credit.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-26
Appendix—The Complete Money
Supply Process (Cont.)
• Shifts between time deposits and checking
accounts (Cont.)
– However, since time deposits are not part of M1,
movement of funds into time deposits will reduce the
expansion of the money supply (M1)
– This suggests that the reserve multiplier
consequences for broader money supply definitions
are more complicated than for M1
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-27
Appendix—The Complete Money
Supply Process (Cont.)
• The role of interest rates
– Banks not being able or willing to lend all their excess
reserves
– These funds may remain idle in the bank
– Since banks will be more inclined to lend or purchase
securities at higher interest rates, this raises the possibility
that the money supply (multiplier) is a function of interest
rate levels
– Figure 18A.2—excess reserves as a percentage of demand
deposits tends to be high when interest rates are low
10
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-28
FIGURE 18A.2 Excess reserves as a percent of
checking deposits tend to be high when the level of the
three-month Treasury bill is low, and vice versa.
Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 18-29
Appendix—The Complete Money
Supply Process (Cont.)
• Implication of the three complications
– The Federal Reserve’s ability to control the
money supply is not precise
– It must deal with leakages of money from the
demand deposit expansion cycle, factors that are
generally determined by public preferences
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