Economics - Money and Banking | Economics

Preview (4 of 13 Pages)

100%

Economics - Money and Banking - Page 1 preview image

Loading page ...

Study GuideEconomics–Money and Banking1. Supply of MoneyThesupply of moneyrefers to the total amount of money available in an economy at a given time.Economists use different definitions to measure it, depending on how broadly they want to define“money.”Types of Money Supply•M1 (Narrowest and most common measure)•This includes:oCurrency in circulation (notes and coins)oCheckable deposits in banks (bank money)oTraveler’s checks•M2 (Broader measure)•This includes everything inM1, plus:oSavings depositsoTime deposits held in banks•M3 (Broadest measure)•This includes everything inM2, plus:oLarge, long-term time deposits (such as certificates of deposit over $100,000)In most discussions, economists focus onM1, because it represents money that can be usedimmediately for spending.1.1Banking Business and the Role of BanksTo understand how money is created, we first need to understandwhat banks do.Banks performtwo main functions:1.Accepting deposits

Economics - Money and Banking - Page 2 preview image

Loading page ...

Study Guide2.People deposit money in banks. In return, banks offer:oA safe place to store moneyoEasy access through checks or debit cardsoSometimes interest payments3.Making loans4.Banks use deposited money to lend to borrowers.5.In this way, banks act asintermediariesbetween savers and borrowers.1.2Reserves and the Reserve RequirementBanks donotkeep all deposited money in their vaults. Why?Because they know thatnot all customers will withdraw their money at the same time.•The portion of deposits that banks keep is calledreserves•Reserves are used to meet withdrawal demands•Thereserve requirementis the fraction of deposits that banks must keep as reserves•This requirement is set by the country’scentral bankMoney that isnot kept as reservesis loaned out to borrowers.Banks earn profits by:•Paying low or zero interest on deposits•Charging higher interest on loans1.3Balance Sheet of a Typical Bank

Economics - Money and Banking - Page 3 preview image

Loading page ...

Study GuideAbalance sheetshows what a bankownsand what itowes.•Assets(what the bank owns):oReservesoLoans•Liabilities(what the bank owes):oDeposits made by customersIn this example:•Total assets = $1,000,000•Total liabilities = $1,000,000✔Assets must always equal liabilities.From this table, we can see that:•Reserves = $100,000•Deposits = $1,000,000So, thereserve requirementis10%.1.4How Banks Create MoneyNow let’s see how banksexpand the money supply.Suppose a bank receives anew deposit of $100,000.•The bank must keep10% ($10,000)as reserves•The remaining$90,000is loaned outIf borrowers deposit this $90,000 back into the bank:•The bank keeps$9,000as reserves•It loans out$81,000This process continues again and again.

Economics - Money and Banking - Page 4 preview image

Loading page ...

Study Guide1.5Multiple Expansion of DepositsThis table shows each round of:•New deposits•New reserves•New loansWhen the process is complete:•Total deposits increase by$1,000,000•Total loans increase by$900,000•Total reserves increase by$100,000All of this started from theoriginal $100,000 deposit.

Preview Mode

This document has 13 pages. Sign in to access the full document!

Report

Economics - Money and Banking

Study Now!

Document Details

Related Documents

Economics - Theory of the Firm

Economics - Theory of the Consumer

Economics - Perfect Competition

Economics - Monopoly

Economics - Monopolistic Competition and Oligopoly

Economics - Labor Market

Economics - Introduction

Economics - GDP, Inflation, and Unemployment

Economics - Fiscal and Monetary Policy

Economics - Demand, Supply, and Elasticity

Company

Explore

Study Tools