Friday, July 17, 2009
Entertaining the possibility...
I am trying to get someone to explain both sides of the fractional vs full reserve systems, and this is a place to ask my questions. I am willing to entertain the possibility that the fractional reserve system is not inherently flawed, and may be useful. I have invited someone from the fractional reserve camp who seems to understand both systems to explain some of the underlying concepts. I ask that there is NO FLAMING on either side of the issue, because it will add nothing to my understanding of the issue.
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Ok for my first question:
ReplyDeleteOK, lets assume 3 banks:
A is the central federal reserve.
B is the regional "federal reserve" bank
C is a local "loan" bank (they only have the initial starting money, and no deposits)
Let us assume a person borrows a sum of money, and pays it back (money creation and destruction) at 10% interest. neither C nor B have the reserve to cover the loan (they borrow then pay back up the chain). If all the rates are 10%,
With a 1/10 fractional reserve system, what is the net effect on the money supply?
With a full reserve system, what is the net effect on the money supply?
also, Is this a valid question? is part of the premise flawed? If so, please help me word the question to figure this out.
I would say that the question is somewhat flawed. First of all, the Federal Reserve System is not a bank. It is the regulatory system, which is run by the Board of Governors, that controls the twelve regional Federal Reserve banks.
ReplyDeleteSecond of all, the money coming in from outside sources isn't considered. Banks borrow money at less interest than they loan out so the interest is covered by some one else.
Regarding what effect a 1/10 fractional reserve will have on the money supply; it will increase it but that is factored into the equation when expanding the money supply.
with the numbers, I'm just trying to keep any math as simple as possible.
ReplyDeleteI just wanted to know whether the supply of money would increase.
in the case above , it would increase.
now with a full reserve system (with the federal reserve system in place) under the same conditions as above, I have a sneaking suspicion that the money supply would increase by the same amount. am I right?
If so, then the full reserve system does not prevent the money supply from increasing.
Let me know if I make a mistake.
copycat
I found an explanation in a forum:
ReplyDelete-----------------------
Assuming a reserve ratio of 10%: Customer 1 deposits $1000 in bank A. Then bank A keeps $100 of that $1000 in reserve and lends $900 to customer 2. Customer 2, in turn, deposits the $900 in Bank B, which in turn lends $910 to Customer 3, keeping $90 in reserve. Cusomer 3, in turn, deposits the $910 in Bank C, which keeps $91 in reserve, lending out $819. And so on. All those bank deposits, which are considered money in their own right, add up to a maximum total of $10,000, or 10 times the original $1000.
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I understand that this is the money creation side of the system. (assuming that it is correct)
now my question:
Assuming that the original $1000 was the total starting money supply, what is the total money supply after the loans are paid off? (money destruction side)