Money, Banking, and International Financehas complete control over how many securities, it buys and sells. With discount loans, the banks
determine whether they want to borrow from the Fed. The Fed cannot force a bank to accept a
loan. However, if the Fed makes more discount loans, subsequently, the Fed’s assets increase,
expanding both the monetary base and money supply. For example, a bank asks the Fed for a
loan of $1 million.
The Bank
Assets Liabilities
Reserves at Fed +$1 million Loan from Fed +$1 million
The Fed
Assets Liabilities
Loan to institution + $1 million Bank reserves +$1 million
Bank’s reserves increased by $1 million, and the bank can grant more loans, expanding the
money supply. When the bank repays the Fed loan, subsequently, the Fed’s assets become
smaller. Furthermore, both the monetary base and the money supply decrease. We show the
transaction below in the T-accounts:
The Bank
Assets Liabilities
Reserves at Fed - $1 million Loan from Fed - $1 million
The Fed
Assets Liabilities
Loan to institution - $1 million Bank deposit at Fed - $1 million
Multiple Deposit Expansion and Contraction
Banking system creates the money supply through multiple deposit expansion. This means
if the Fed increases the monetary base by $1, then the amount of checkable deposits in the
banking system will increase by more than $1. Checkable deposits are a component of the M1
definition of money, consequently, the money supply increases by more than $1. We show the
multiple deposit expansion by using an example.
The Federal Reserve increases the money supply, so the Fed buys a $10,000 U.S. T-bill
from you. You take the Fed check and deposit the whole $10,000 at your bank into your
checking account. We record the transaction in the T-account on the next page.