ECON 2030 Chapter : 16-Apr
Practice problems: chapter 31: 5-8, 10, 11,19
Chapter 36: 5,8,15
a. Money: How do banks create it?
a. Model: money supply = MB X money multiplier
i. MB = monetary base = bank reserves + currency in circulation
ii.
b. Multiple deposit creation: a fairy tale
i. Children that have teeth that fall out and are going to be
replaced.
ii. Losing the first tooth and take the tooth and (the problem with
them is that they are not a liquid asset—you can’t buy stuff
with them) you put them under your pillow and magically over
night the tooth fairy converts the teeth to a liquid asset of
money. For example, a 100 dollar bill.
iii. The child doesn’t need it now so goes and deposits it an
interest bearing checking account and receives a receipt. The
receipt is actually and I owe you a hundred dollars. The
depositer is actually lending to the bank.
iv. The commercial banks and non banking public does not change
the monetary base in our actions and decisions (like
withdrawal and deposits).
v. The banks is a business and wants to earn money. When the
banks takes in my deposit they have inccured cost: they need
to pay the teller, manage the account, sent a receipt to you at
the end of the month. If they incur cost and don’t make any
money off of that 100 dollars they wont survive long.
vi. So how do they earn income as a bank? By turning around and
taking some of what you borrowed and lend it They borrow in
order to lend.
vii. Why does this work: because you can exchange the money in
your checking account for money any time.
viii. If the bank has a money multiplier of one it is making no
money. As soon as the bank loans one penny the multiplier
goes up to make money.
c. Conclusions:
i. Suppose all of us, go to an atm and make withdrawals from our
hecking accounts, this means there are less deposits at the
bank and this means that the banks has the ability to lend less
and smaller money multiplier and less profit.
ii. More deposits, more loans, greater multiplier, greater money
supply
iii. Fewer deposits, fewer loan, lower mulitplier, lower money
supply
1. If we don’t deposit it they cant lend it.
