alomar_111_mcp1 money creation process. alomar_111_mcp2 a person opens a checking account at bank...

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Alomar_111_MCP 1 Money Creation Process

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Page 1: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 1

Money Creation Process

Page 2: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 2

A person opens a checking account at bank (A) with (KD100) in cash.

This rises the liability of the bank by (100)

If the bank keeps the (100) in cash, this rises the assets side of the balance sheet

Page 3: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 3

A L

Page 4: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 4

Since cash is part of bank’s reserves, the (100) becomes reserves now

A L

Page 5: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 5

If the required reserve ratio = 10%, then reserves can be divided into:

Required reserves = (10%)(100)=KD10

Excess reserves = 100-10= KD90

Page 6: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 6

A L

Page 7: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 7

Since excess reserves earn no interest. Bank (A) may choose to make a loan worth of (90). (why not lend the 100)?

The bank make profits now: (interest paid on loan) – (interest

paid on deposits)

Page 8: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 8

A L

RR 10 Checkable D 100ER 0Loans 90

Page 9: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 9

Assume now that your friend who borrowed the (KD90), went to bank (A) and opened a checking account

Page 10: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 10

A L

RR 19 Checkable D1 100ER 81 Checkable D2 90Loans 90 190 190

Page 11: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 11

Total deposits = KD190 Since excess reserves earn no

interest, bank (A) will make a loan of the (81) to another person.

Excess reserves = 0 Total loans = KD171

Page 12: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 12

A LRR 19 Checkable D1 100ER 0 Checkable D2 90Loans 171 190 190

Page 13: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 13

This process will continue… We started with (KD100) but total

deposits increased by more than the initial (KD100)

This is called “money creation”

Page 14: Alomar_111_MCP1 Money Creation Process. Alomar_111_MCP2 A person opens a checking account at bank (A) with (KD100) in cash. This rises the liability of

Alomar_111_MCP 14

Deposit multiplier = 1/rrr = 1/0.10=10 Thus, the total amount of deposits

bank (A) can create = (10)(100) = KD1000

Total loans = 1000 – 100 = 900(total deposits – total required

reserve)