Sign Banking PDF California Myself

Industry sign banking california pdf myself

hey how you doing econ students this is mr clifford welcome to ac dc econ right now we're going to talk about how banks create money out of thin air you heard me right banks create money out of thin air to explain how this is possible let's talk about what a bank does a bank accepts deposits from its customers but it doesn't just hold that money if all banks did was hold other people's money there'd be no profit in that instead what a bank does it takes that money and it loans most of it out now why can't it loan all of it out well because sometimes customers come back and they want to withdraw some of that money so if you and i and everybody else goes to the bank at the same time to get our money out the bank does not have that money they wouldn't be able to pay us and the bank would default now that's called a bank run and it's bad really bad now the united states we have deposit insurance make sure bank runs like that don't happen but the point is the bank doesn't hold all those deposits they loan it out now the amount of deposits that the bank needs to hold by law is called a required reserve in the united states it's ten percent this means that the other ninety percent is something called excess reserves and they're free to loan that out it'll make a whole lot more sense with an example let's say someone goes into a bank and deposits a hundred dollars from their pocket into the bank now this won't change the money supply because money from your pocket is part of money supply and so is demand deposits inside banks so so far there's been no change in the money supply but here's where the magic happens the bank is going to hold a certain percentage by law let's say ten percent so they're gonna hold ten dollars that means we're gonna loan the other ninety out now the person who deposited a hundred dollars has a hundred dollars in the bank but the person who borrowed the ninety also has now ninety dollars that ninety dollars is money that was created from thin air that did not exist until the lawn occurred now that person's gonna spend that ninety dollars and eventually that ninety dollars is gonna make its way back into another bank that other bank is gonna take that ninety dollars it's gonna hold ten percent and require reserves so nine dollars is going to hold and it's gonna loan the other 81 out that 81 new dollars is new money supply it was not created until the loan occurred now eventually the person who borrowed the money is going to take it and spend it and that's going to make its way to a new bank and the same thing's gonna happen again and again and again and again and again now it turns out that the initial deposit of a hundred dollars is actually gonna become nine hundred dollars of new money created the way i got this is by looking at something called the money multiplier which is one over the reserve ratio so in this case when the reserve ratio was ten percent that meant the money multiplier is one over point one so it's ten now you might be asking yourself if the initial amount deposited was a hundred dollars and the multiplier is ten why didn't a thousand dollars of new money get created the reason why is because the initial hundred dollars was actually part of the money supply to start off with so the only amount of new money that was created was from the initial loan of ninety dollars and so ninety dollars times ten is nine hundred dollars of new money created from the initial loan and this is the whole idea of fractional reserve banking banks hold a portion of deposits and they loan the rest out and whenever they loan it out they create new money did you get that here let me ask you a question to see if you actually fully understand that concept let's assume instead that the reserve requirement is 20 and someone deposits 500 into their bank from their pocket in the bank 500 assuming that banks loan out all of their excess reserves and there's no other leakages how much would be the increase in the money supply well the money multiplier is one over point two it's multiplier is five that bank is gonna hold a hundred dollars in required reserves and their excess reserves of four hundred dollars they're going to loan out that 400 is all new money and all the other steps cause new money and so it's 400 times five which is two thousand dollars now don't confuse this idea of skipping that first round with the same idea of the fed buying bonds for example if the fed bought 500 worth of bonds so the fed buys bonds and puts 500 in the system that whole 500 is new money so in that situation the new money created would be 500 times 5 which would be 2 500. now this is tricky but it's just like the spending multiplier that you learned back when you learn fiscal policy make sure to take a look at my other videos and my review apps for the ap economics test until next time