[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Table 28.4
REQUIRED RESERVES
Bank deposits and type
Minimum reserve required
(percentage of deposits)
Checking accounts at banks with
more than $46.5 million in deposits 10
Checking accounts at banks with
less than $46.5 million in deposits 3
All other deposits 0
SOURCE: Federal Reserve Bulletin (1999).
required to hold reserves, at levels imposed by the Fed. Today, the amount of reserves
they hold is dictated more by regulations than by the banks’ own perceptions of
what is prudent. After all, holding T-bills is just as safe as holding reserves with the
Fed—and yields higher returns. And the level of reserves required by the Fed is
designed primarily with an eye not to maximizing their profit but to controlling the
money supply and thereby the level of economic activity. Table 28.4 shows the current
reserve requirements. This system of banking, in which banks hold a fraction
of the amount on deposit in reserves, is called a fractional reserve system.
The liability side of AmericaBank’s balance sheet consists of two items: deposits
and net worth. Deposits include checking accounts, which are technically known as
demand deposits, and a variety of forms of savings accounts, which are technically
known as time deposits. The bank’s net worth is simply the difference between the value
of its assets and the value of its liabilities. In other words, if the bank’s assets were
sold and its depositors paid off, what remained would equal the net worth of the
bank. By including net worth in the column for liabilities, we ensure that the numbers
on both sides of the balance sheet always balance when we add up each column.
HOW BANKS CREATE MONEY
As we have seen, the currency manufactured by the Treasury is a relatively small
part of the money supply. The rest of the money is created by banks. To understand
this process, let us consider all 9,500 U.S. banks as one huge superbank. Now suppose
that a multibillionaire deposits $1 billion in currency into her account with this
superbank.
The bank knows it must keep enough funds to satisfy the reserve requirement
set by the Fed. Currently, the Fed requires that reserves be 10 percent of demand
deposits, so its reserve-to-deposit ratio must be 1 to 10. The bank also has a long line
of loan applicants. When the bank makes a loan, it does not actually give the borrower
currency. It credits him with funds in his checking account. It does this by
622 ∂ CHAPTER 28 MONEY, THE PRICE LEVEL, AND THE FEDERAL RESERVE