MODERN MONEY MECHANICS
A Workbook on Bank Reserves and
Deposit Expansion
Federal Reserve Bank of
Chicago
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Introduction
The purpose of this
booklet is to describe the basic process of money creation in a
"fractional reserve" banking system. The approach taken illustrates
the changes in bank balance sheets that occur when deposits in banks change as
a result of monetary action by the Federal Reserve System - the central bank of
the United States. The relationships shown are based on simplifying
assumptions. For the sake of simplicity, the relationships are shown as if they
were mechanical, but they are not, as is described later in the booklet. Thus,
they should not be interpreted to imply a close and predictable relationship between
a specific central bank transaction and the quantity of money.
The introductory pages
contain a brief general description of the characteristics of money and how the
U.S. money system works. The illustrations in the following two sections
describe two processes: first, how bank deposits expand or contract in response
to changes in the amount of reserves supplied by the central bank; and second,
how those reserves are affected by both Federal Reserve actions and other
factors. A final section deals with some of the elements that modify, at least
in the short run, the simple mechanical relationship between bank reserves and
deposit money.
Money is such a routine
part of everyday living that its existence and acceptance ordinarily are taken
for granted. A user may sense that money must come into being either
automatically as a result of economic activity or as an outgrowth of some
government operation. But just how this happens all too often remains a
mystery.
What is Money?
If money is viewed simply
as a tool used to facilitate transactions, only those media that are readily
accepted in exchange for goods, services, and other assets need to be
considered. Many things - from stones to baseball cards - have served this
monetary function through the ages. Today, in the United States, money used in
transactions is mainly of three kinds - currency (paper money and coins in the
pockets and purses of the public); demand deposits (non-interest bearing
checking accounts in banks); and other checkable deposits, such as negotiable
order of withdrawal (NOW) accounts, at all depository institutions, including
commercial and savings banks, savings and loan associations, and credit unions.
Travelers checks also are included in the definition of transactions money.
Since $1 in currency and $1 in checkable deposits are freely convertible into
each other and both can be used directly for expenditures, they are money in
equal degree. However, only the cash and balances held by the nonbank public
are counted in the money supply. Deposits of the U.S. Treasury, depository
institutions, foreign banks and official institutions, as well as vault cash in
depository institutions are excluded.
This transactions concept
of money is the one designated as M1 in the Federal Reserve's money stock
statistics. Broader concepts of money (M2 and M3) include M1 as well as certain
other financial assets (such as savings and time deposits at depository
institutions and shares in money market mutual funds) which are relatively
liquid but believed to represent principally investments to their holders
rather than media of exchange. While funds can be shifted fairly easily between
transaction balances and these other liquid assets, the money-creation process
takes place principally through transaction accounts. In the remainder of this
booklet, "money" means M1.
The distribution between
the currency and deposit components of money depends largely on the preferences
of the public. When a depositor cashes a check or makes a cash withdrawal
through an automatic teller machine, he or she reduces the amount of deposits
and increases the amount of currency held by the public. Conversely, when
people have more currency than is needed, some is returned to banks in exchange
for deposits.
While currency is used for
a great variety of small transactions, most of the dollar amount of money
payments in our economy are made by check or by electronic transfer between
deposit accounts. Moreover, currency is a relatively small part of the money
stock. About 69 percent, or $623 billion, of the $898 billion total stock in
December 1991, was in the form of transaction deposits, of which $290 billion
were demand and $333 billion were other checkable deposits.
What Makes Money
Valuable?
In the United States
neither paper currency nor deposits have value as commodities. Intrinsically, a
dollar bill is just a piece of paper, deposits merely book entries. Coins do
have some intrinsic value as metal, but generally far less than their face
value.
What, then, makes these
instruments - checks, paper money, and coins - acceptable at face value in
payment of all debts and for other monetary uses? Mainly, it is the confidence
people have that they will be able to exchange such money for other financial
assets and for real goods and services whenever they choose to do so.
Money, like anything else,
derives its value from its scarcity in relation to its usefulness.
Commodities or services are more or less valuable because there are more or
less of them relative to the amounts people want. Money's usefulness is its
unique ability to command other goods and services and to permit a holder to be
constantly ready to do so. How much money is demanded depends on several
factors, such as the total volume of transactions in the economy at any given
time, the payments habits of the society, the amount of money that individuals
and businesses want to keep on hand to take care of unexpected transactions,
and the forgone earnings of holding financial assets in the form of money
rather than some other asset.
Control of the quantity
of money is essential if its value is to be kept stable. Money's real value can
be measured only in terms of what it will buy. Therefore, its value varies
inversely with the general level of prices. Assuming a constant rate of use, if
the volume of money grows more rapidly than the rate at which the output of
real goods and services increases, prices will rise. This will happen because
there will be more money than there will be goods and services to spend it on
at prevailing prices. But if, on the other hand, growth in the supply of money
does not keep pace with the economy's current production, then prices will
fall, the nations's labor force, factories, and other production facilities
will not be fully employed, or both.
Just how large the stock of
money needs to be in order to handle the transactions of the economy without
exerting undue influence on the price level depends on how intensively money is
being used. Every transaction deposit balance and every dollar bill is part of
somebody's spendable funds at any given time, ready to move to other owners as
transactions take place. Some holders spend money quickly after they get it,
making these funds available for other uses. Others, however, hold money for
longer periods. Obviously, when some money remains idle, a larger total is
needed to accomplish any given volume of transactions.
Who Creates Money?
Changes in the quantity of
money may originate with actions of the Federal Reserve System (the central
bank), depository institutions (principally commercial banks), or the public.
The major control, however, rests with the central bank.
The actual process
of money creation takes place primarily in banks.(1) As noted earlier, checkable liabilities of banks
are money. These liabilities are customers' accounts. They increase when
customers deposit currency and checks and when the proceeds of loans made by
the banks are credited to borrowers' accounts.
In the absence of legal
reserve requirements, banks can build up deposits by increasing loans and
investments so long as they keep enough currency on hand to redeem whatever
amounts the holders of deposits want to convert into currency. This unique
attribute of the banking business was discovered many centuries ago.
It started with goldsmiths.
As early bankers, they initially provided safekeeping services, making a profit
from vault storage fees for gold and coins deposited with them. People would
redeem their "deposit receipts" whenever they needed gold or coins to
purchase something, and physically take the gold or coins to the seller who, in
turn, would deposit them for safekeeping, often with the same banker. Everyone
soon found that it was a lot easier simply to use the deposit receipts directly
as a means of payment. These receipts, which became known as notes, were
acceptable as money since whoever held them could go to the banker and exchange
them for metallic money.
Then, bankers discovered
that they could make loans merely by giving their promises to pay, or bank
notes, to borrowers. In this way, banks began to create money. More notes could
be issued than the gold and coin on hand because only a portion of the notes
outstanding would be presented for payment at any one time. Enough metallic
money had to be kept on hand, of course, to redeem whatever volume of notes was
presented for payment.
Transaction deposits are
the modern counterpart of bank notes. It was a small step from printing notes
to making book entries crediting deposits of borrowers, which the borrowers in
turn could "spend" by writing checks, thereby "printing"
their own money.
What Limits the Amount
of Money Banks Can Create?
If deposit money can be
created so easily, what is to prevent banks from making too much - more than
sufficient to keep the nation's productive resources fully employed without
price inflation? Like its predecessor, the modern bank must keep available, to
make payment on demand, a considerable amount of currency and funds on deposit
with the central bank. The bank must be prepared to convert deposit money into
currency for those depositors who request currency. It must make remittance on
checks written by depositors and presented for payment by other banks (settle
adverse clearings). Finally, it must maintain legally required reserves, in the
form of vault cash and/or balances at its Federal Reserve Bank, equal to a
prescribed percentage of its deposits.
The public's demand for
currency varies greatly, but generally follows a seasonal pattern that is quite
predictable. The effects on bank funds of these variations in the amount of
currency held by the public usually are offset by the central bank, which
replaces the reserves absorbed by currency withdrawals from banks. (Just how
this is done will be explained later.) For all banks taken together, there is
no net drain of funds through clearings. A check drawn on one bank normally
will be deposited to the credit of another account, if not in the same bank,
then in some other bank.
These operating needs
influence the minimum amount of reserves an individual bank will hold
voluntarily. However, as long as this minimum amount is less than what is
legally required, operating needs are of relatively minor importance as a
restraint on aggregate deposit expansion in the banking system. Such expansion
cannot continue beyond the point where the amount of reserves that all banks
have is just sufficient to satisfy legal requirements under our
"fractional reserve" system. For example, if reserves of 20 percent
were required, deposits could expand only until they were five times as large
as reserves. Reserves of $10 million could support deposits of $50 million. The
lower the percentage requirement, the greater the deposit expansion that can be
supported by each additional reserve dollar. Thus, the legal reserve ratio
together with the dollar amount of bank reserves are the factors that set the
upper limit to money creation.
What Are Bank Reserves?
Currency held in bank
vaults may be counted as legal reserves as well as deposits (reserve balances)
at the Federal Reserve Banks. Both are equally acceptable in satisfaction of
reserve requirements. A bank can always obtain reserve balances by sending
currency to its Reserve Bank and can obtain currency by drawing on its reserve
balance. Because either can be used to support a much larger volume of deposit
liabilities of banks, currency in circulation and reserve balances together are
often referred to as "high-powered money" or the "monetary
base." Reserve balances and vault cash in banks, however, are not counted
as part of the money stock held by the public.
For individual
banks, reserve accounts also serve as working balances.(2) Banks may increase the balances in their
reserve accounts by depositing checks and proceeds from electronic funds
transfers as well as currency. Or they may draw down these balances by writing
checks on them or by authorizing a debit to them in payment for currency,
customers' checks, or other funds transfers.
Although reserve accounts
are used as working balances, each bank must maintain, on the average for the
relevant reserve maintenance period, reserve balances at their Reserve Bank and
vault cash which together are equal to its required reserves, as determined by
the amount of its deposits in the reserve computation period.
Where Do Bank Reserves
Come From?
Increases or decreases in
bank reserves can result from a number of factors discussed later in this
booklet. From the standpoint of money creation, however, the essential point is
that the reserves of banks are, for the most part, liabilities of the Federal
Reserve Banks, and net changes in them are largely determined by actions of the
Federal Reserve System. Thus, the Federal Reserve, through its ability to vary
both the total volume of reserves and the required ratio of reserves to deposit
liabilities, influences banks' decisions with respect to their assets and
deposits. One of the major responsibilities of the Federal Reserve System is to
provide the total amount of reserves consistent with the monetary needs of the
economy at reasonably stable prices. Such actions take into consideration, of
course, any changes in the pace at which money is being used and changes in the
public's demand for cash balances.
The reader should be
mindful that deposits and reserves tend to expand simultaneously and that the
Federal Reserve's control often is exerted through the market place as
individual banks find it either cheaper or more expensive to obtain their
required reserves, depending on the willingness of the Fed to support the
current rate of credit and deposit expansion.
While an individual bank
can obtain reserves by bidding them away from other banks, this cannot be done
by the banking system as a whole. Except for reserves borrowed temporarily from
the Federal Reserve's discount window, as is shown later, the supply of
reserves in the banking system is controlled by the Federal Reserve.
Moreover, a given increase
in bank reserves is not necessarily accompanied by an expansion in money equal
to the theoretical potential based on the required ratio of reserves to
deposits. What happens to the quantity of money will vary, depending upon the
reactions of the banks and the public. A number of slippages may occur. What
amount of reserves will be drained into the public's currency holdings? To what
extent will the increase in total reserves remain unused as excess reserves?
How much will be absorbed by deposits or other liabilities not defined as money
but against which banks might also have to hold reserves? How sensitive are the
banks to policy actions of the central bank? The significance of these
questions will be discussed later in this booklet. The answers indicate why
changes in the money supply may be different than expected or may respond to
policy action only after considerable time has elapsed.
In the succeeding pages,
the effects of various transactions on the quantity of money are described and
illustrated. The basic working tool is the "T" account, which
provides a simple means of tracing, step by step, the effects of these
transactions on both the asset and liability sides of bank balance sheets.
Changes in asset items are entered on the left half of the "T" and
changes in liabilities on the right half. For any one transaction, of course,
there must be at least two entries in order to maintain the equality of assets
and liabilities.
1In order to describe the money-creation process as
simply as possible, the term "bank" used in this booklet should be
understood to encompass all depository institutions. Since the Depository
Institutions Deregulation and Monetary Control Act of 1980, all depository
institutions have been permitted to offer interest bearing transaction accounts
to certain customers. Transaction accounts (interest bearing as well as demand
deposits on which payment of interest is still legally prohibited) at all
depository institutions are subject to the reserve requirements set by the
Federal Reserve. Thus all such institutions, not just commercial banks, have
the potential for creating money. back
2Part of an individual bank's reserve account may represent its reserve balance used to meet its reserve requirements while another part may be its required clearing balance on which earnings credits are generated to pay for Federal Reserve Bank services. back
Bank Deposits - How They Expand or
Contract
Let us assume that
expansion in the money stock is desired by the Federal Reserve to achieve its
policy objectives. One way the central bank can initiate such an expansion is
through purchases of securities in the open market. Payment for the securities
adds to bank reserves. Such purchases (and sales) are called "open market
operations."
How do open market
purchases add to bank reserves and deposits? Suppose the Federal Reserve
System, through its trading desk at the Federal Reserve Bank of New York, buys
$10,000 of Treasury bills from a dealer in U. S. government securities.(3) In
today's world of
computerized financial transactions, the Federal Reserve Bank pays for the
securities with an "telectronic" check drawn on itself.(4) Via its "Fedwire" transfer
network, the Federal Reserve notifies the dealer's designated bank (Bank A)
that payment for the securities should be credited to (deposited in) the
dealer's account at Bank A. At the same time, Bank A's reserve account at the
Federal Reserve is credited for the amount of the securities purchase. The
Federal Reserve System has added $10,000 of securities to its assets, which it
has paid for, in effect, by creating a liability on itself in the form
of bank reserve balances. These reserves on Bank A's books are matched by
$10,000 of the dealer's deposits that did not exist
before. See illustration 1.
How the Multiple
Expansion Process Works
If the process ended here,
there would be no "multiple" expansion, i.e., deposits and bank
reserves would have changed by the same amount. However, banks are required to
maintain reserves equal to only a fraction of their deposits. Reserves in
excess of this amount may be used to increase earning assets - loans and
investments. Unused or excess reserves earn no interest. Under current
regulations, the reserve requirement against most transaction accounts is 10
percent.(5) Assuming, for
simplicity, a uniform 10 percent reserve requirement against all transaction
deposits, and further assuming that all banks attempt to remain fully invested,
we can now trace the process of expansion in deposits which can take place on
the basis of the additional reserves provided by the Federal Reserve System's
purchase of U. S. government securities.
The expansion process may
or may not begin with Bank A, depending on what the dealer does with the money
received from the sale of securities. If the dealer immediately writes checks
for $10,000 and all of them are deposited in other banks, Bank A loses both
deposits and reserves and shows no net change as a result of the System's open
market purchase. However, other banks have received them. Most likely, a part
of the initial deposit will remain with Bank A, and a part will be shifted to
other banks as the dealer's checks clear.
It does not really matter
where this money is at any given time. The important fact is that these
deposits do not disappear. They are in some deposit accounts at all times.
All banks together have $10,000 of deposits and reserves that they did not have
before. However, they are not required to keep $10,000 of reserves against the
$10,000 of deposits. All they need to retain, under a 10 percent reserve
requirement, is $1000. The remaining $9,000 is "excess reserves."
This amount can be loaned or invested. See illustration
2.
If business is active, the banks with excess reserves probably will have opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000. Reserves are unchanged by the loan transactions. But the deposit credits constitute new additions to the total deposits of the banking system. See illustration 3.
3Dollar amounts used in the various illustrations do
not necessarily bear any resemblance to actual transactions. For example, open
market operations typically are conducted with many dealers and in amounts
totaling several billion dollars. back
4Indeed, many transactions today are accomplished
through an electronic transfer of funds between accounts rather than through
issuance of a paper check. Apart from the time of posting, the accounting
entries are the same whether a transfer is made with a paper check or
electronically. The term "check," therefore, is used for both types
of transfers. back
5For each bank, the reserve requirement is 3 percent on a specified base amount of transaction accounts and 10 percent on the amount above this base. Initially, the Monetary Control Act set this base amount - called the "low reserve tranche" - at $25 million, and provided for it to change annually in line with the growth in transaction deposits nationally. The low reserve tranche was $41.1 million in 1991 and $42.2 million in 1992. The Garn-St. Germain Act of 1982 further modified these requirements by exempting the first $2 million of reservable liabilities from reserve requirements. Like the low reserve tranche, the exempt level is adjusted each year to reflect growth in reservable liabilities. The exempt level was $3.4 million in 1991 and $3.6 million in 1992. back
Deposit Expansion
1. When the Federal Reserve Bank purchases government
securities, bank reserves increase. This happens because the seller of the
securities receives payment through a credit to a designated deposit account at
a bank (Bank A) which the Federal Reserve effects by crediting the reserve
account of Bank A.
|
FR BANK |
BANK A |
|
Assets |
Liabilities |
|
Assets |
Liabilities |
|
US
govt |
Reserve
acct. |
Reserves
with |
Customer
|
The customer deposit at Bank A likely will be transferred, in part, to other banks and quickly loses its identity amid the huge interbank flow of deposits. back
|
2.As a
result, all banks taken together |
Total reserves gained from new deposits.......10,000 |
Expansion - Stage 1
3.Expansion takes place only if the banks that hold these
excess reserves (Stage 1 banks) increase their loans or investments. Loans are
made by crediting the borrower's account, i.e., by creating additional deposit
money. back
|
STAGE 1 BANKS |
|
Assets |
Liabilities |
|
Loans....... +9,000 |
Borrower deposits....
+9,000 |
This is the beginning of
the deposit expansion process. In the first stage of the process, total loans and deposits of the
banks rise by an amount equal to the excess reserves existing before any loans
were made (90 percent of the initial deposit increase). At the end of Stage 1,
deposits have risen a total of $19,000 (the initial $10,000 provided by the
Federal Reserve's action plus the $9,000 in deposits created by Stage 1 banks). See illustration 4. However, only $900 (10 percent of
$9000) of excess reserves have been absorbed by the additional deposit growth
at Stage 1 banks. See illustration 5.
The lending banks, however,
do not expect to retain the deposits they create through their loan operations.
Borrowers write checks that probably will be deposited in other banks. As these
checks move through the collection process, the Federal Reserve Banks debit the
reserve accounts of the paying banks (Stage 1 banks) and credit those of the receiving banks. See illustration
6.
Whether Stage 1 banks
actually do lose the deposits to other banks or whether any or all of
the borrowers' checks are redeposited in these same banks makes no
difference in the expansion process. If the lending banks expect to lose
these deposits - and an equal amount of reserves - as the borrowers' checks are
paid, they will not lend more than their excess reserves. Like the original
$10,000 deposit, the loan-credited deposits may be transferred to other banks,
but they remain somewhere in the banking system. Whichever banks receive them
also acquire equal amounts of reserves, of which all but 10 percent will be
"excess."
Assuming that the banks
holding the $9,000 of deposits created in Stage 1 in turn make loans equal to
their excess reserves, then loans and deposits will rise by a further $8,100 in
the second stage of expansion. This process can continue until deposits have
risen to the point where all the reserves provided by the initial purchase of
government securities by the Federal Reserve System are just sufficient to
satisfy reserve requirements against the newly created deposits.(See pages10 and 11.)
The individual bank, of
course, is not concerned as to the stages of expansion in which it may be
participating. Inflows and outflows of deposits occur continuously. Any deposit
received is new money, regardless of its ultimate source. But if bank policy is
to make loans and investments equal to whatever reserves are in excess of legal
requirements, the expansion process will be carried on.
How Much Can Deposits
Expand in the Banking System?
The total amount of
expansion that can take place is illustrated on page 11. Carried through to
theoretical limits, the initial $10,000 of reserves distributed within the
banking system gives rise to an expansion of $90,000 in bank credit (loans and
investments) and supports a total of $100,000 in new deposits under a 10
percent reserve requirement. The deposit expansion factor for a given amount of
new reserves is thus the reciprocal of the required reserve percentage (1/.10 =
10). Loan expansion will be less by the amount of the initial injection. The
multiple expansion is possible because the banks as a group are like one large
bank in which checks drawn against borrowers' deposits result in credits to
accounts of other depositors, with no net change in the total reserves.
Expansion through Bank
Investments
Deposit expansion can
proceed from investments as well as loans. Suppose that the demand for loans at
some Stage 1 banks is slack. These banks would then probably purchase
securities. If the sellers of the securities were customers, the banks would
make payment by crediting the customers' transaction accounts, deposit
liabilities would rise just as if loans had been made. More likely, these banks
would purchase the securities through dealers, paying for them with checks on
themselves or on their reserve accounts. These checks would be deposited in the
sellers' banks. In either case, the net effects on the banking system are
identical with those resulting from loan operations.
4 As a result of the process so far, total assets and
total liabilities of all banks together have risen 19,000. back
|
ALL BANKS |
|
Assets |
Liabilities |
|
Reserves
with F. R. Banks...+10,000 |
Deposits: Initial. . .
.+10,000 |
5Excess reserves have been reduced by the amount
required against the deposits created by the loans made in Stage 1. back
|
Total reserves gained from initial deposits. . . .
10,000 |
Why do these banks stop increasing their loans
and deposits when they still have excess reserves?
6 ...because borrowers write checks on their
accounts at the lending banks. As these checks are deposited in the payees'
banks and cleared, the deposits created by Stage 1 loans and an equal amount of
reserves may be transferred to other banks. back
|
STAGE 1 BANKS |
|
Assets |
Liabilities |
|
Reserves
with F. R. Banks . -9000 |
Borrower
deposits . . . -9,000 |
|
FEDERAL RESERVE BANK |
|
Assets |
Liabilities |
|
|
Reserve
accounts: Stage 1 banks . -9,000 |
|
OTHER BANKS |
|
Assets |
Liabilities |
|
Reserves
with F. R. Banks . +9,000 |
Deposits . . . . . . . . .
+9,000 |
Deposit expansion has just
begun!
7Expansion continues as the banks
that have excess reserves increase their loans by that amount, crediting
borrowers' deposit accounts in the process, thus creating still more money.
|
STAGE 2 BANKS |
|
Assets |
Liabilities |
|
Loans . . . . . . . . +
8100 |
Borrower deposits . . .
+8,100 |
8Now the banking system's assets and
liabilities have risen by 27,100.
|
ALL BANKS |
|
Assets |
Liabilities |
|
Reserves
with F. R. Banks . +10,000 |
Deposits:
Initial . . . . +10,000 |
9 But there are still 7,290 of excess
reserves in the banking system.
|
Total reserves gained from initial deposits . . . .
. 10,000 |
10 As borrowers make payments, these
reserves will be further dispersed, and the process can continue through many
more stages, in progressively smaller increments, until the entire 10,000 of
reserves have been absorbed by deposit growth. As is apparent from the summary
table on page 11, more than two-thirds of the deposit expansion potential is
reached after the first ten stages.
It should be understood that the stages of expansion occur neither
simultaneously nor in
the sequence described above. Some banks use their reserves incompletely or
only after a
considerable time lag, while others expand assets on the basis of expected
reserve growth.
The process is, in fact, continuous and may never reach its theoretical limits.
End page 10. back
Thus through stage after stage of expansion,
"money" can grow to a total of 10 times the new
reserves supplied to the banking system....
|
Assets |
Liabilities |
|
|
[ |
Reserves |
] |
|
|
Total |
(Required) |
(Excess) |
Loans and |
Deposits |
|
Reserves
provided |
10,000 |
1,000 |
9,000 |
- |
10,000 |
|
Exp.
Stage 1 |
10,000 |
1900 |
8,100 |
9,000 |
19,000 |
|
Stage2 |
10,000 |
2,710 |
7,290 |
17,100 |
27,100 |
|
Stage
3 |
10,000 |
3,439 |
6,561 |
24,390 |
34,390 |
|
Stage
4 |
10,000 |
4,095 |
5,905 |
30,951 |
40,951 |
|
Stage
5 |
10,000 |
4,686 |
5,314 |
36,856 |
46,856 |
|
Stage
6 |
10,000 |
5,217 |
4,783 |
42,170 |
52,170 |
|
Stage
7 |
10,000 |
5,695 |
4,305 |
46,953 |
56,953 |
|
Stage
8 |
10,000 |
6,126 |
3,874 |
51,258 |
61,258 |
|
Stage
9 |
10,000 |
6,513 |
3,487 |
55,132 |
65,132 |
|
Stage
10 |
10,000 |
6,862 |
3,138 |
58,619 |
68,619 |
|
... |
... |
... |
... |
... |
... |
|
... |
... |
... |
... |
... |
... |
|
... |
... |
... |
... |
... |
... |
|
Stage
20 |
10,000 |
8,906 |
1,094 |
79,058 |
89,058 |
|
... |
... |
... |
... |
... |
... |
|
... |
... |
... |
... |
... |
... |
|
... |
... |
... |
... |
... |
... |
|
Final
Stage |
10,000 |
10,000 |
0 |
90,000 |
100,000 |
...as the new deposits created by loans
at each stage are added to those created at all
earlier stages and those supplied by the initial
reserve-creating action.
End page 11. back
How Open Market Sales
Reduce bank Reserves and Deposits
Now suppose some reduction
in the amount of money is desired. Normally this would reflect temporary or
seasonal reductions in activity to be financed since, on a year-to-year basis,
a growing economy needs at least some monetary expansion. Just as purchases of
government securities by the Federal Reserve System can provide the basis for
deposit expansion by adding to bank reserves, sales of securities by the
Federal Reserve System reduce the money stock by absorbing bank reserves. The
process is essentially the reverse of the expansion steps just described.
Suppose the Federal Reserve
System sells $10,000 of Treasury bills to a U.S. government securities dealer
and receives in payment an "electronic" check drawn on Bank A. As
this payment is made, Bank A's reserve account at a Federal Reserve Bank is
reduced by $10,000. As a result, the Federal Reserve System's holdings of
securities and the reserve accounts of banks are both reduced $10,000. The
$10,000 reduction in Bank A's depost liabilities constitutes a decline in the money stock. See illustration 11.
Contraction Also Is a
Cumulative Process