CHAPTER 33 AP Macroeconomics: Money Creation

fractional reserve banking system

A banking system where banks keep only a fraction of their deposits on hand, lending out the rest to earn interest.

characteristics of fractional reserve banking system

banks create money through lending; banks operate on basis of fractional reserves are vulnerable to “panics” or “runs” where everyone tries to withdraw money simultaneously

balance sheet for commercial banks

for commercial banks displays assets, liabilities, and equity at a specific point in time. Assets include cash, loans, and investments, while liabilities consist of deposits and borrowings. Equity represents the bank's net worth.

Assets = liabilities + net worth

vault cash

the physical currency that a business keeps on hand to meet day-to-day cash needs and ensure liquidity for transactions, also called TILL MONEY

required reserves

the minimum amount of funds that banks must hold in reserve against deposits to meet central bank regulations and ensure liquidity, to a specified % of bank’s own deposit liabilities

reserve ratio

the percentage of deposits that banks must hold as reserves, set by central banks to ensure liquidity and stability in the financial system.

reserve ratio formula

= (required reserves of bank) / (checkable-deposit liabilities of bank)

excess reserves

the extra money banks keep beyond what they're required to hold. They keep this to stay safe or when there aren't good lending options.

Actual Reserves

all the money a bank has saved up at the central bank, including both the required and excess reserves. This total helps the bank manage its daily needs and follow rules.

Excess reserves equation?

Actual reserves - required resserves (AR - RR = ER)

How can banks create money? (2)

1) making loans creates money 2) creates money by purchasing government bonds from the public

2 conflicting goals of commerical bank

1) profit (loans+securities) for earnings and 2) liquidity for safety

federal funds rate

the interest rate that banks charge each other for overnight loans. It helps control other interest rates and the economy.

monetary multiplier

The ratio of the change in the money supply to the initial change in reserves, showing how much the money supply can expand.

= 1/Required reserve ratio