The following worksheet should teach you :

1. How a Cash Deposit at a bank effects:

a. the bank's balance sheet
b. M1 (the money supply) - HINT: there is no effect

2. How Money is Created when a bank grants a loan

a. Know the balance sheet changes when the loan is granted (see below)

b. Know the balance sheet changes when the check is cleared (see below)

3. How much money can be created by the banking system when there is an increase in excess reserves

Print the following to use while going through the worksheet:

• moneycreblank.htm

Banks create money during their normal operations of accepting deposits and making loans. In this example we'll use M1 as our definition of money. (M1 = currency in our pockets and balances in our checking accounts.) When a bank makes a loan it creates money. For example when I got a loan to buy my boat, my credit union called an told me that the loan was approved and that I should come in and get the check. I told them to just deposit it in my checking account. So they did. they turned on their computers, typed in my account number, and added the loan to my checking account balance. I now had more money (M1). The bank created this money when they gave me the loan.

To learn how banks create money during their normal activities of accepting deposits and making loans lets assume that a $10 bill is deposited in the First National Bank (FNB). We will use the balance sheets of banks to see the effects. Our balance sheets will only show the CHANGES made to them. Our study guide has problems where they show actual (but hypothetical) amounts in the bank's T-account.

Major Point: An initial increase in funds available to the banking industry results in a MULTIPLE increase in the money supply.

There is a Three Step Process per Round:

1. An increase in demand deposits or other liabilities of a bank increases the bank’s reserves.
2. Bank can make loans equal to its excess reserves. Loans made by increasing demand deposits.
3. The loan check is spent, deposited in a different bank, and CLEARS. First bank now has no excess reserves, but second does and can therefore make a loan.

Formulas:

Total Reserves = Cash in vault + Deposits at Fed.

Required Reserves = RR x Liabilities

• Liabilities are the Demand Deposits or DD
• RR is the Required Reserve ration set by the Fed
• NOTE: a common error is that students calculate the Required Reserves by: RR x Reserves. DON'T DO THIS!. To calculate the Required Reserves: RR x Liabilities
• total reserves are also called "actual reserves"

Excess Reserves = Total Reserves - Required Reserves

Excess Reserves are used by banks to:

1. make loans
2. pay back depositors when they remove their funds from their accounts (like write a check)

Change in Money Supply = initial Excess Reserves x Money Multiplier

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