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chapter 15
Multiple Deposit Creation
and the Money Supply Process
Four Players in the Money Supply
Process
1. Central bank: the Fed
2. Banks
3. Depositors
4. Borrowers from banks
Federal Reserve System
1. Conducts monetary policy
2. Clears checks
3. Regulates banks
Copyright © 2001 Addison Wesley Longman
TM 15- 2
The Monetary Base
1. MB = C + R = (Fed notes) + (bank deposits) + (Treasury currency) –
(coin)
Asset = Liabilities of Fed balance sheet 
2. (Fed notes) + (bank deposits) = (securities) + (discount loans) +
(gold and SDRs) + (coin) + (cash items in process of collection) +
(other Fed assets) – (Treasury deposits) – (foreign and other deposits) –
(deferred-availability cash items) – (other Fed liabs)
Float = (cash items in process of collection) – (deferred-availability cash
items)
Substituting 2 into 1 and using definition of float:
MB = (securities) + (discount loans) + (gold and SDRs) + (float) + (other
Fed assets) + (Treasury currency) – (Treasury deposits) – (foreign and
other deposits) – (other Fed liabs)
Copyright © 2001 Addison Wesley Longman
TM 15- 3
Summary: Factors that Affect the
Monetary Base
Copyright © 2001 Addison Wesley Longman
TM 15- 4
Control of the Monetary Base
MB = C + R
Open Market Purchase from Bank
The Banking System
Assets
Liabilities
The Fed
Assets
Liabilities
Securities – $100
Reserves + $100
Open Market Purchase from Public
Public
Assets
Liabilities
Securities + $100
Reserves + $100
The Fed
Assets
Liabilities
Securities – $100
Deposits + $100
Banking System
Assets
Securities + $100
Reserves + $100
Liabilities
Reserves
+ $100
Checkable Deposits
+ $100
Result: R  $100, MB  $100
Copyright © 2001 Addison Wesley Longman
TM 15- 5
If Person Cashes Check
Public
Assets
Liabilities
The Fed
Assets
Securities – $100
Securities + $100
Currency + $100
Result: R unchanged, MB  $100
Effect on MB certain, on R uncertain
Liabilities
Currency + $100
Shifts From Deposits into Currency
Public
Assets
Liabilities
Deposits – $100
Currency + $100
Banking System
Assets
The Fed
Assets
Liabilities
Currency + $100
Reserves – $100
Liabilities
Reserves – $100 Deposits – $100
Result: R  $100, MB unchanged
Copyright © 2001 Addison Wesley Longman
TM 15- 6
Discount Loans
Banking System
Assets
Liabilities
Reserves
Discount
+ $100
loan + $100
The Fed
Assets
Discount
loan + $100
Liabilities
Reserves
+ $100
Result: R  $100, MB  $100
Conclusion: Fed has better ability to control MB than R
Copyright © 2001 Addison Wesley Longman
TM 15- 7
Deposit Creation: Single Bank
Assets
Securities
Reserves
Assets
Securities
Reserves
Loans
Assets
Securities
Loans
Copyright © 2001 Addison Wesley Longman
First National Bank
Liabilities
– $100
+ $100
First National Bank
Liabilities
– $100
+ $100
+ $100
Deposits
+ $100
First National Bank
Liabilities
– $100
+ $100
Deposits
+ $100
TM 15- 8
Deposit Creation: Banking System
Assets
Reserves
Assets
Reserves
Loans
Assets
Reserves
Assets
Reserves
Loans
Copyright © 2001 Addison Wesley Longman
+ $100
+ $10
+ $90
+ $90
+$9
+ $81
Bank A
Liabilities
Deposits
+ $100
Bank A
Liabilities
Deposits
+ $100
Bank B
Liabilities
Deposits
+ $90
Bank B
Liabilities
Deposits
+ $90
TM 15- 9
Deposit Creation
Copyright © 2001 Addison Wesley Longman
TM 15- 10
Deposit Multiplier
If Bank A buys securities with $90 check
Bank A
Assets
Liabilities
Reserves
+ $10
Deposits
+ $100
Securities
+ $90
Seller deposits $90 at Bank B and process is same
Whether bank makes loans or buys securities, get same
deposit expansion
Copyright © 2001 Addison Wesley Longman
TM 15- 11
Deposit Multiplier
Simple Deposit Multiplier
1
D =
 R
rD
Deriving the formula
R = RR = rD  D
D=
1
rD
R
D =
1
rD
 R
Copyright © 2001 Addison Wesley Longman
TM 15- 12
Banking System As a Whole
Banking System
Assets
Liabilities
Securities – $100
Deposits
Reserves + $100
Loans
+ $1000
+ $1000
Critique of Simple Model
Deposit creation stops if:
1. Proceeds from loan kept in cash
2. Bank holds excess reserves
Copyright © 2001 Addison Wesley Longman
TM 15- 13