APMacro: Money Creating Transactions

5 Clearing a Check
In addition to accepting deposits, commercial banks can create money by making loans to borrowers and by purchasing government bonds from the public. When a bank makes loans, it creates money.

6a When a Loan is Negotiated
In transaction 6a, there was a change in the composition of the money supply, but no change in the supply of money. When banks lend, they create checkable deposits that are money. By extending credit, the bank has monetized an IOU. The claim created by a borrower and given to the bank is not money; an individual IOU is not acceptable as a medium of exchange. But the claim created by the bank and given to the borrower is money; checks drawn against a checkable deposit are acceptable as a medium of exchange.

Much of the money we use in our economy is created through the extension of credit by commercial banks. This checkable deposit money may be thought of as debts of commercial banks and thrift institutions. Checkable deposits are bank debts in the sense that they are claims that banks and thrifts promise to pay on demand.

6b After a Check Is Drawn on the Loan
The borrower writes a check for $50,000 drawn against the borrower’s bank and is deposited in another bank. The check is collected in the manner described in an earlier lesson (transaction 5). As a result the bank loses both reserves and deposits equal to the amount of the check. After the check has been collected, the bank just meets the required reserve ratio of 20 percent. The bank has no excess reserves.A single commercial bank in a multibanking system can lend only an amount equal to its initial preloan excess reserves.

7a Buying Government Securities
When a bank buys government bonds from the public, the effect is substantially the same as lending. New money is created. Suppose that instead of making a $50,000 loan, the bank buys $50,000 of government securities from a securities dealer. The bank receives the interest bearing bonds which appear on its balance sheet as the asset “Securities” and gives the dealer an increase in its checkable deposit account. Checkable deposits, that is the supply of money, have been increased by $50,000. Bond purchases from the public by commercial banks increase the supply of money in the same way as lending to the public does. The bank accepts government bonds, which are not money, and gives the securities dealer an increase in its checkable deposits, which is money.

7b Buying Government Securities
When the securities dealer draws and clears a check of $50,000 against the bank, the bank loses both reserves and deposits in that amount and the just meets the legal reserve requirement.

Finally, the selling of government bonds to the public by a commercial bank, like the repayment of a loan, reduces the supply of money. the securities buyer pays by check and both “Securities” and “Checkable deposits” decline by the amount of the sale.

1) Read Chapter 13 pp.245-254.  Answer questions #1, 2, 4, 5, 6, 7, 8, 9, 10, 12, 13
2) Learnerator: Demand & Supply Equilibrium #1-24, Macroeconomic issues #1-15



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