Hello bildy,
Okay, let's attack this one question at a time.
1. To begin, a deposit of $300 at Bank One is made. So Bank One has
the following T-account structure:
BANK ONE
Assets Liabilities
-----------------|------------------------
Reserves +$300 Checkable Deposits +$300
We'll assume that all other banks hold no excess reserves.
With a required reserve ratio of 0.12, Bank One now finds itself with
a $36 increase in required reserves ($300 * 0.12), which leaves it
with $264 of excess reserves. Bank One doesn't want to hold on to
excess reserves, so it will loan out the entire amount. Its loans and
checkable depotsits will then increase by $264, but when the borrower
spends the $264 of checkable deposits they and the reserves at Bank
One will fall back down by the same amount. The T-account will look
like this:
BANK ONE
Assets Liabilities
-----------------|------------------------
Reserves +$36 Checkable Deposits +$300
Loans +$264
If the money borrowed from Bank One is deposited in another bank, say
Bank Two, then the T-account for Bank Two looks like this:
BANK TWO
Assets Liabilities
-----------------|------------------------
Reserves +$264 Checkable Deposits +$264
The checkable deposits in the banking system as a whole have just
increased by another $264, for a total increase (including the
checkable deposits at Bank One) of $564. Actually, to be precise, the
deposit wouldn't even have to be made at Bank Two for this two happen.
If the borrower of the $264 deposited the money at Bank One, the
T-account for you just saw for Bank Two would apply to Bank One, and
the same net effect would occur, i.e. a total increase of $564 in the
banking system.
Bank Two also doesn't want to hold excess reserves. It must keep 12%
of $264, or $31.68, and will lend the remainder out. So the T-account
will now look like:
BANK TWO
Assets Liabilities
-----------------|------------------------
Reserves +$31.68 Checkable Deposits +$264
Loans +$232.32
The cycle will continue, where the loan from Bank Two could now go to
Bank Three, etc. Eventually, the total increase in deposits will be
the reciprocal of the reserve ratio times the initial deposit. This
ratio ( 1 / RRR) is the demand deposit multiplier that you asked about
in Question 3:
Total Deposits = (1 / Req. Reserve Ratio) * Initial Deposits
In this case that would be
(1 / 0.12) * $300 = $2500
Question 2.
The Federal Reserve Board of Governors is made up of seven governors
appointed by the President to serve one nonrenewable fourteen-year
term. One governor's term expires every other January. The Board of
Governors is actively involved with decisions concerning the conduct
of monetary policy. The Board also sets reserve requirements. It has
effective control over the discount rate as well, because it reviews
the discount rate established by the Federal Reserve Banks, and
approves or disapproves of it.
The Board also has some other functions that aren't quite as directly
related to monetary policy. For instance, it sets margin requirements
for securities (the portion of the purchase price that has to be paid
with cash rather than borrowed funds); it sets the salary of the
president and all officers of each Federal Reserve Bank; and it has
regulatory functions like approving bank mergers.
The Federal Open Market Committee (FOMC) is made up of twelve members.
This includes the seven members of the Board of Governors, so they
form the majority. The other five members are the president of the
Federal Reserve Bank of New York, and the presidents of four other
Federal Reserve Banks (rotating appointments).
The Fed uses open market operations to control the money supply, so
the FOMSC is the focal point for policy-making in the Federal Reserve
System. Decisions regarding the discount rate and reserve
requirements are effectively made by the FOMC, though they are set by
the Reserve Board. The FOMC issues directives to the trading desk at
the Federal Reserve Bank of New York to carry out security purchases
or sales, and the FRBNY carries out any trading that the FOMC directs.
So, the FOMC has control over open market operations, and the FRB is
intended to have control over monetary policy. But of course, the
FOMC is made up of only 12 members, seven of whom are FRB governors,
so the distinction of control is a bit blurry.
Question 3.
The Fed can increase the money supply by providing additional reserves
to the banking system in one of two ways. It can make loans to the
banks, or it can purchase government bonds. It can increase the loans
it makes to the bank by lowering its interest rate, making it cheaper
for banks to borrow money. It could also reduce reserve requirements,
which would allow more money to be lent out by the banks.
If the Fed makes a loan to a bank, say Bank One from the first
question, the reserves of Bank One rise by whatever amount it is,
let's say $300 again, and its liabilities rise by $300.
BANK ONE
Assets Liabilities
-----------------|--------------------------------
Reserves +$300 Discount loan from the Fed +$300
The same items appear in the Fed's T-account, but backwards because
for the Fed, reserves are a liability (payable on demand to Bank One)
and the discount loan is an asset because it generates income for the
Fed.
THE FED
Assets Liabilities
----------------------|--------------------------
Discount loan to
Bank One +$300 Reserves +$300
As you saw in question 1, this increases the money supply by some
amount, depending on the required reserve ratio.
Alternatively, the Fed can purchase government bonds. This is an open
market operation, which is what is controlled by the FOMC. The way it
works is the Fed goes and buys some amount of bonds from Bank One and
pays for them with a check written on the New York Federal Reserve
Bank (remember, that's who executes the trades dictated by the FOMC).
Bank One deposits the check with the Fed and it is then credited to
Bank One's reserve account. The net result is that bank One's balance
sheet sees its securities holdings fall by the value of the bond
purchase (say $1000), and it has gained the same amount in reserves.
BANK ONE
Assets Liabilities
--------------------|------------------------
Securities -$1000
Reserves +$1000
The Fed's liabilities have increased by $1000 because reserves have
now increased by that amount, but it has an extra $1000 is bonds,
which appear as an increase in government securities. So it's
T-account looks like:
THE FED
Assets Liabilities
-----------------------------|------------------------
Government securities +$1000 Reserves +$1000
Generally, an increase in the money supply will increase the amount
that people and firms will hold, and increase the amount they spend,
which increases aggreagate demand. The Fed will increase the money
supply if it feels the economy is operating well below its potential
level of output, with the aim of increasing both employment and
output.
Question 4.
Financial intermediares are the organizations that operate between
corporate borrowers and lenders. For instance, if you Microsoft
decides that it wants to borrow money (though I don't think they have
any real need to), they don't borrow directly from you. Instead, they
borrow from financial intermediaries, which are commercial banks,
savings and loans, mutual savings banks, credit unions, mutual funds,
pension funds, insurance companies, and finance companies. These
institutions borrow money from you (you deposit money with them), and
then lend it to someone else (like Microsoft).
Without intermediaries, borrowers would have to go around looking for
lenders individually, and negotiate terms with each one. This could
prove be easy if you want fifty bucks to go out on the town for a
night, but may be difficult if you need a billion dollars to build a
new microchip plant. So, no, the US could not realistically do
without intermediaries.
Question 5.
The Federal Reserve is the central bank of the United States. It's
made up of twelve Federal Reserve banks in major cities around the
country, and the Board of Governors, which is located in Washington
D.C.
It performs a number of functions:
- It has some control over the money supply through monetary policy
which affects the banks.
- It clears checks, which really means that it transfers funds between
banks to settle claims that are made when a check written on one bank
is deposited at another.
- It sets the rules on how the banks operate (such things as the
required reserve ratio).
Which is the most important is really a question of what you value
most. Every function is quite important, and the banking industry
would be in rough shape if any one of them were not handled properly.
But one could probably say without too much risk of dispute that the
monetary policy control is its most important, and certainly its most
visible function.
I think that just about answers all your questions. I don't have any
web resources for you to look at, unfortunately, but if you have
access to a good library you may want to find a book called The
Economics of Money, Banking, and Financial Markets by Frederic
Mishkin, which is a well written, easy to follow text. I refer to it
often when dealing with these sorts of questions.
If anything isn't quite clear, please ask for a clarification. |
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