Transcript Financial Intermediaries

Financial Intermediaries
AP Macroeconomics
http://en.wikipedia.org/wiki/File:Stacks_of_money.jpg
Where we came from…
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In this lesson, we’ll
learn about the
relationship between
the money supply and
GDP.
The Equation of
Exchange is an
identity and provides
an understanding of
the relationship
between money and
economic activity.
http://www.writemoneyinc.com/
Where are we going?
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In this lesson, we’ll
discuss financial
intermediaries, which are
the go-between borrowers
and lenders.
Financial intermediaries
take deposits from
households and
businesses and make
loans to other households
and businesses.
In essence, they help
money circulate through
the economy.
http://sparkcharts.sparknotes.com/economics/macroeconomics/section2.php
How do banks create money?
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First, what is a bank?
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A bank is any depository
institution whose
deposits are part of M1.
Great…now we can
begin to evaluate
how, exactly, banks
create money!
http://www.stlouisfed.org/inplainenglish/reserve_banks.htm
Examples of Financial Intermediaries…
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Bank of America
Chase
J.P. Morgan
Asheville Savings Bank
(You get the point)
http://financialintermediaries.org/
Functions of Financial Intermediaries
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http://www.thebull.com.au/articles_detail.php?id=428
Create liquidity (a liquid
asset can be quickly
converted into cash
without much loss of
value, such as loans,
bonds, stocks, etc.)
Minimize the cost of
borrowing
Minimize the cost of
monitoring borrowing and
risk reduction through
pooling
Fractional Reserve System
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Banks are institutions
that hold deposits
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People deposit money in
a bank.
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Banks must hold a
specific percentage of
the deposit as reserves
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http://jimmyquetron.studentbs.com/2011/02/21/bank-deposits/
This percentage is
called the required
reserve ratio
The deposit that is not
part of required reserve
is called excess
reserves.
How does a bank make loans?
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The bank might loan excess reserves or buy
government securities.
This increases the money supply.
Remember that the money supply, M1,
equals currency, checkable deposits, and
traveler’s checks.
So how do banks create money?!?!
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Let’s say someone
deposits $2,000 into a
checkable account in
the bank.
There is an initial effect
on this deposit…
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The economy’s
checkable deposits will
rise by $2,000.
Then, the bank’s
reserves will rise by
$2,000.
http://www.marketoracle.co.uk/Article3652.html
So, how do banks create money?
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“What affect does this have on the money
supply?” At first, none:
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Currency in circulation, part of money supply,
will go down by $2,000.
However, as previously mentioned, checkable
accounts/bank deposits (which are also part of
money supply) rise by $2,000.
So, how do banks create money?
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But, let’s say that the bank holds onto a portion of
that deposit, say %10 (or $200). The bank then
loans out the rest to another household ($1800).
The bank’s reserves are now reduced by $200, but
the money supply has increased to $3,800 (because
the initial deposit of $2,000 is still in the checkable
account and $1,800 has been loaned to someone
else).
Let’s say that the recipient of that loan deposits the
$1,800 into another bank…the process begins
again!
What do you suppose this process is called?
The Multiplier
Process!
(the $ multiplier, that is)
…don’t you wish you
owned a money
multiplier?
http://boldleaders.ning.com/profiles/blogs/ripple-effect-we-are-the
What is the money multiplier?
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It tells us the total number of dollars created
in the banking system by each $1 addition to
the monetary base (the sum of currency in
circulation and the reserves held by banks).
So ultimately, it is that initial deposit plus the
subsequent rounds of deposits initiated by
that first deposit.
Ok, so what is it? (the formula, that is)
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Ultimately, the multiplier itself if the inverse of
the required reserve ratio (rr).
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If the rr is 10%, or .1, then the multiplier is 10.
Thus, the ripple effect as of our example would be
$2000 is $20,000.
Another way to calculate: $2,000/.1 =
$20,000.
IMPORTANT NOTE…
Note that the US has a fractional reserve
system because the required reserve ratio is
not 1.
And now…
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Some resources:
http://www.reffonomics.com/
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For information on federal reserve banks, you can
visit:
http://www.stlouisfed.org/inplainenglish/reserve_b
anks.htm
Morton workbook Activity 37
Works Cited
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Economics of Seinfeld.
http://yadayadayadaecon.com/
Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth
Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.