Tuesday 915

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 10 Money and Prices in the Long Run
Chapter 29 of 36 The Monetary System
Section 15 of 20
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The process of money creation by banks can continue forever, but not an infinite amount.
If there is an initial deposit at a bank of $100 with a bank reserve requirement of 10%, ultimately an additional $900 of money can be created.
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The amount of money the banking system generates with each dollar of reserves is called the money multiplier.
Per Figure B example, with a 0.10 reserve ratio
· the money multiplier is 1/.1 = 10
· $100 of reserves (initial deposit) eventually can create $900 more money created = $1000 total
The money multiplier is the reciprocal of the reserve ratio.
In the example
· reserve requirement is 0.1 so the money multiplier is 1/.1 = 10
· $100/.1 = $100 x 10 = $1000 total money end result, original $100 deposit + $900 created money.
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This formula illustrates how the amount of money banks create depends on the reserve ratio.
If the reserve ratio was .05
· meaning a money multiplier of 20
· $2000 would be created from $100
If the reserve ratio was .20
· meaning a money multiplier of 5
· $500 would be created from $100
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In the case of 100% reserve requirement banking
· banks do not make loans so they do not create money
· the reserve ratio is 1
· the money multiplier is 1
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infinite amount of money
museigen no ryō no okane
無制限の量のお金
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Why did banks fail during the Great Depression? ChatGPT:
Banks failed during the Great Depression because they did not keep all deposited money sitting in their vaults.
They operated on fractional-reserve banking: they kept only a portion of deposits as cash and loaned or invested the rest.
Normally this worked because depositors did not all demand their money at the same time.
After the stock-market crash of 1929 and the worsening economic downturn, several things happened together:
-borrowers could not repay loans
-farms and businesses failed
-property and securities held by banks fell sharply in value
-frightened depositors began withdrawing cash
A bank might have had enough assets to cover its deposits eventually, but it could not quickly turn those assets into cash without taking large losses.
Once rumors spread a bank was in trouble, a bank run could develop. Hundreds or thousands of customers tried to withdraw their deposits simultaneously.
The bank could run out of cash and close.
The especially important difference from today was federal deposit insurance did not yet exist.
Before the Federal Deposit Insurance Corporation (FDIC) began operating in 1934, a person whose bank failed had no federal guarantee the government would replace the money in the account.
They might eventually recover some of their money as the bank's assets were liquidated, but they could lose a substantial portion — or occasionally nearly all of it.
Bank failures then made the Depression worse.
People became afraid to leave money in banks, so they hoarded cash.
Banks became reluctant to make new loans.
Businesses had more difficulty borrowing, investment and spending declined, and falling prices increased the real burden of existing debts.
The Federal Reserve also failed to provide banks with enough cash and emergency financial support to stop many of the banking panics.
The constraints of the gold-standard system made an aggressive money supply increase more difficult.
So the basic chain was: economic losses → fear about banks → mass withdrawals → banks forced to sell assets or close → uninsured depositors lose money → less lending and spending → an even deeper Depression.
This experience is the main reason Congress created the FDIC in 1933, so depositors would no longer have to rush to withdraw their money because they feared their bank might fail.
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Why did people even put their money in banks when they knew from history they could lose their money during an economic depression? CGPT:
Because, despite the risk, banks were still much more useful and usually safer than keeping large amounts of cash at home.
People used banks for several practical reasons.
Banks protected money from theft, fire, and simple loss.
They allowed people to write checks and make payments.
They often paid interest on deposits.
Businesses needed bank accounts to handle payroll, receipts, and loans.
Most banks also operated normally most of the time, so an individual depositor could reasonably believe his bank was sound even if banks had failed during earlier financial panics.
People generally did not expect a collapse on the scale of 1929–1933.
The United States had experienced banking panics before, such as the Panic of 1907, but the economy had quickly recovered.
Many people therefore thought another downturn would be temporary rather than a catastrophe in which thousands of banks would fail.
Keeping one's life savings at home had serious drawbacks.
A person with the equivalent of tens of thousands of today's dollars would have had to hide physical currency or gold somewhere.
It could be stolen, destroyed in a fire, or lost.
So for most people, putting money in a reputable local bank still seemed like the more sensible choice.
Some people did distrust banks and kept substantial amounts of cash at home.
During the Depression that behavior became much more common.
The irony is when millions of people simultaneously decided withdrawing their money was safer, those withdrawals helped create the very bank runs that caused otherwise viable banks to fail.
So the typical attitude before the Depression was not, "Banks can't fail."
The prevailing attitude was: "Banks sometimes fail, but my bank probably won't and if it does I’ll eventually get my money back, and keeping all my money at home is even less practical."