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9 Edition: Prepared by M. Hassan Kazimi September 2020

This document defines money and its functions, types, and supply. It explains how fractional reserve banking allows banks to create money by lending out deposits. When a loan is made, new money is created and the money supply expands. While banks can generate new money through lending, this process does not create new wealth itself, as it only transfers existing purchasing power between economic actors. The central bank controls monetary policy and the money supply.

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29 views

9 Edition: Prepared by M. Hassan Kazimi September 2020

This document defines money and its functions, types, and supply. It explains how fractional reserve banking allows banks to create money by lending out deposits. When a loan is made, new money is created and the money supply expands. While banks can generate new money through lending, this process does not create new wealth itself, as it only transfers existing purchasing power between economic actors. The central bank controls monetary policy and the money supply.

Uploaded by

hassankazimi23
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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9th Edition

Prepared by M. Hassan Kazimi


Prepared by M. Hassan Kazimi
September 2020 September 2020
IN THIS CHAPTER, YOU WILL LEARN

• The Money: Definition, Functions and Types of money

• Money Supply and Monetary Policy

• How banks “create” money


Money: Definition
Money is the stock of
assets that can be
readily used to make
transactions
Money: Functions
1. Medium of exchange:
We use it to buy stuffs and services

2. Store of value:
Transfers purchasing power from the present to the future

3. Unit of account:
The common unit by which everyone measures prices and values
Money: Types

1. Fiat money:
 has no intrinsic value
example: the paper currency we use

2. Commodity money:
has intrinsic value
examples: gold coins,
Money Supply
• Money supply is the quantity of money available in the
economy
• It equals currency plus demand (checking account) deposits:
M=C+D
(M = money Supply, C = Currency, D = Deposits)
Monetary Policy and The Central Bank

• Monetary policy is the control over the

money supply

• Monetary policy is conducted by a

country’s central bank.

• The Afghanistan’s Central Bank is

called “Da Afghanistan Bank”


Banks’ role in the Monetary System
• To understand the role of banks, we will consider three
scenarios:
1. No banks
2. 100-percent-reserve banking (banks hold all deposits as
reserves)
3. Fractional-reserve banking (banks hold a fraction of deposits as
reserves, use the rest to make loans)
• In each scenario, we assume: C = $ 1,000.
SCENARIO 1: No banks

With no banks:
 D=0
 M = C = $1,000
SCENARIO 2: 100-percent-reserve banking

• Initially C = $ 1,000, D = $0, M = $ 1,000


• Now suppose households deposit the $1,000 at “bank”

FIRST BANK’s After the deposit:


• C=$0
balance sheet
• D = $1,000
Assets Liabilities • M = $1,000
• LESSON: 100%-reserve
Reserves $ 1,000 Deposits $ 1,000 banking has no impact on
size of money supply
SCENARIO 3: Fractional-reserve banking

• Suppose banks hold 20% of deposits in reserve, making loans with the
rest.
• First bank will make $800 in loans.
FIRST BANK’s • The money supply now equals
balance sheet $1,800:
Assets Liabilities  Depositor has $1,000 in demand
deposits.
Reserves $ 200 (20%) Deposits $ 1,000  Borrower holds $800 in currency
Loans $ 800 (80%)
SCENARIO 3:
Fractional-reserve banking
• Suppose the borrower deposits the $800 in Second bank.

• Second bank’s balance sheet is:


SECOND BANK’s Second bank will loan
balance sheet 80% of this deposit
Assets Liabilities

Reserves $ 160 (20%) Deposits $ 800


Loans $ 640 (80%)
SCENARIO 3:
Fractional-reserve banking
• If this $640 is eventually deposited in Third bank,
• Then third bank will keep 20% of it in reserve and loan the
rest out:
THIRD BANK’s
balance sheet
Assets Liabilities

Reserves $ 128 (20%) Deposits $ 640


Loans $ 512 (80%)
Finding the Total Amount of Money
• Original deposit = $1,000
+ First bank lending = $ 800
+ Second bank lending = $ 640
+ Third bank lending = $ 512
+ other lending…
---------------------------------------------------------------------------
Total money supply = (1/rr ) × $1,000
• rr = ratio of reserves to deposits
• In this example, rr = 0.2 (20 %),
• so M = $5,000
Critical Question

The fractional-reserve banking system creates money

Can it create wealth?

Why?
CHAPTER SUMMARY
Money:
• Definition: the stock of assets used for transactions
• Functions: medium of exchange, store of value, unit of
account
• Types: commodity money (has intrinsic value), fiat money
(no intrinsic value)
• Money supply controlled by central bank
• Fractional reserve banking creates money but it doesn’t
create wealth
Next Lecture
• Many Multiplier?
• How the central Bank can control money Supply?
• Bank capital, leverage, capital requirements?
Thank you

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