<< Chapter < Page Chapter >> Page >

By the end of this section, you will be able to:

  • Utilize the money multiplier formulate to determine how banks create money
  • Analyze and create T-account balance sheets
  • Evaluate the risks and benefits of money and banks

Banks and money are intertwined. It is not just that most money is in the form of bank accounts. The banking system can literally create money through the process of making loans. Let’s see how.

Money creation by a single bank

Start with a hypothetical bank called Singleton Bank. The bank has $10 million in deposits. The T-account balance sheet for Singleton Bank, when it holds all of the deposits in its vaults, is shown in [link] . At this stage, Singleton Bank is simply storing money for depositors and is using these deposits to make loans. In this simplified example, Singleton Bank cannot earn any interest income from these loans and cannot pay its depositors an interest rate either.

Singleton bank’s balance sheet: receives $10 million in deposits

The assets are reserves ($10 million). The liabilities + net worth are deposits ($10 million).

Singleton Bank is required by the Federal Reserve to keep $1 million on reserve (10% of total deposits). It will loan out the remaining $9 million. By loaning out the $9 million and charging interest, it will be able to make interest payments to depositors and earn interest income for Singleton Bank (for now, we will keep it simple and not put interest income on the balance sheet). Instead of becoming just a storage place for deposits, Singleton Bank can become a financial intermediary between savers and borrowers.

This change in business plan alters Singleton Bank’s balance sheet, as shown in [link] . Singleton’s assets have changed; it now has $1 million in reserves and a loan to Hank’s Auto Supply of $9 million. The bank still has $10 million in deposits.

Singleton bank’s balance sheet: 10% reserves, one round of loans

The assets are reserves ($1 million) and loan to hank’s auto supply ($9 million). The liabilities + net worth are deposits ($10 million).

Singleton Bank lends $9 million to Hank’s Auto Supply. The bank records this loan by making an entry on the balance sheet to indicate that a loan has been made. This loan is an asset, because it will generate interest income for the bank. Of course, the loan officer is not going to let Hank walk out of the bank with $9 million in cash. The bank issues Hank’s Auto Supply a cashier’s check for the $9 million. Hank deposits the loan in his regular checking account with First National. The deposits at First National rise by $9 million and its reserves also rise by $9 million, as [link] shows. First National must hold 10% of additional deposits as required reserves but is free to loan out the rest

First national balance sheet

The assets are reserves (+ $9 million). The liabilities + net worth are deposits (+ $9 million).

Making loans that are deposited into a demand deposit account increases the M1 money supply. Remember the definition of M1 includes checkable (demand) deposits, which can be easily used as a medium of exchange to buy goods and services. Notice that the money supply is now $19 million: $10 million in deposits in Singleton bank and $9 million in deposits at First National. Obviously these deposits will be drawn down as Hank’s Auto Supply writes checks to pay its bills. But the bigger picture is that a bank must hold enough money in reserves to meet its liabilities; the rest the bank loans out. In this example so far, bank lending has expanded the money supply by $9 million.

Questions & Answers

are nano particles real
Missy Reply
yeah
Joseph
Hello, if I study Physics teacher in bachelor, can I study Nanotechnology in master?
Lale Reply
no can't
Lohitha
where we get a research paper on Nano chemistry....?
Maira Reply
nanopartical of organic/inorganic / physical chemistry , pdf / thesis / review
Ali
what are the products of Nano chemistry?
Maira Reply
There are lots of products of nano chemistry... Like nano coatings.....carbon fiber.. And lots of others..
learn
Even nanotechnology is pretty much all about chemistry... Its the chemistry on quantum or atomic level
learn
Google
da
no nanotechnology is also a part of physics and maths it requires angle formulas and some pressure regarding concepts
Bhagvanji
hey
Giriraj
Preparation and Applications of Nanomaterial for Drug Delivery
Hafiz Reply
revolt
da
Application of nanotechnology in medicine
has a lot of application modern world
Kamaluddeen
yes
narayan
what is variations in raman spectra for nanomaterials
Jyoti Reply
ya I also want to know the raman spectra
Bhagvanji
I only see partial conversation and what's the question here!
Crow Reply
what about nanotechnology for water purification
RAW Reply
please someone correct me if I'm wrong but I think one can use nanoparticles, specially silver nanoparticles for water treatment.
Damian
yes that's correct
Professor
I think
Professor
Nasa has use it in the 60's, copper as water purification in the moon travel.
Alexandre
nanocopper obvius
Alexandre
what is the stm
Brian Reply
is there industrial application of fullrenes. What is the method to prepare fullrene on large scale.?
Rafiq
industrial application...? mmm I think on the medical side as drug carrier, but you should go deeper on your research, I may be wrong
Damian
How we are making nano material?
LITNING Reply
what is a peer
LITNING Reply
What is meant by 'nano scale'?
LITNING Reply
What is STMs full form?
LITNING
scanning tunneling microscope
Sahil
how nano science is used for hydrophobicity
Santosh
Do u think that Graphene and Fullrene fiber can be used to make Air Plane body structure the lightest and strongest. Rafiq
Rafiq
what is differents between GO and RGO?
Mahi
what is simplest way to understand the applications of nano robots used to detect the cancer affected cell of human body.? How this robot is carried to required site of body cell.? what will be the carrier material and how can be detected that correct delivery of drug is done Rafiq
Rafiq
if virus is killing to make ARTIFICIAL DNA OF GRAPHENE FOR KILLED THE VIRUS .THIS IS OUR ASSUMPTION
Anam
analytical skills graphene is prepared to kill any type viruses .
Anam
Any one who tell me about Preparation and application of Nanomaterial for drug Delivery
Hafiz
what is Nano technology ?
Bob Reply
write examples of Nano molecule?
Bob
The nanotechnology is as new science, to scale nanometric
brayan
nanotechnology is the study, desing, synthesis, manipulation and application of materials and functional systems through control of matter at nanoscale
Damian
Is there any normative that regulates the use of silver nanoparticles?
Damian Reply
what king of growth are you checking .?
Renato
Equilibrium price is a stable price and it must stay.discuss
Elvis Reply
Card 14 / 21: What are the similarities between a consumer’s budget constraint and society’s production possibilities frontier, not just graphically but analytically?
Ali Reply

Get Jobilize Job Search Mobile App in your pocket Now!

Get it on Google Play Download on the App Store Now




Source:  OpenStax, Principles of macroeconomics for ap® courses. OpenStax CNX. Aug 24, 2015 Download for free at http://legacy.cnx.org/content/col11864/1.2
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of macroeconomics for ap® courses' conversation and receive update notifications?

Ask