Modern Money Mechanics - by The Federal Reserve Bank of Chicago (text format)

MODERN MONEY MECHANICSA Workbook on Bank Reserves and Deposit ExpansionThis complete booklet was originally produced and distributed free by:Public Information CenterFederal Reserve Bank of ChicagoP. O. Box 834Chicago, IL 60690-0834 It is now out of print.IntroductionThe purpose of this booklet is to describe the basic process of money creation in a"fractional reserve" banking system. The approach taken illustrates the changes in bankbalance sheets that occur when deposits in banks change as a result of monetary actionby the Federal Reserve System - the central bank of the United States. The relationshipsshown are based on simplifying assumptions. For the sake of simplicity, the relationshipsare shown as if they were mechanical, but they are not, as is described later in thebooklet. Thus, they should not be interpreted to imply a close and predictablerelationship between a specific central bank transaction and the quantity of money.The introductory pages contain a brief general description of the characteristics ofmoney and how the U.S. money system works. The illustrations in the following twosections describe two processes: first, how bank deposits expand or contract in responseto changes in the amount of reserves supplied by the central bank; and second, how thosereserves are affected by both Federal Reserve actions and other factors. A final sectiondeals with some of the elements that modify, at least in the short run, the simplemechanical relationship between bank reserves and deposit money.Money is such a routine part of everyday living that its existence and acceptanceordinarily are taken for granted. A user may sense that money must come into beingeither automatically as a result of economic activity or as an outgrowth of somegovernment operation. But just how this happens all too often remains a mystery.What is Money?If money is viewed simply as a tool used to facilitate transactions, only those media thatare readily accepted in exchange for goods, services, and other assets need to beconsidered. Many things - from stones to baseball cards - have served this monetaryfunction through the ages. Today, in the United States, money used in transactions ismainly of three kinds - currency (paper money and coins in the pockets and purses of the public); demand deposits (non-interest bearing checking accounts in banks); and othercheckable deposits, such as negotiable order of withdrawal (NOW) accounts, at alldepository institutions, including commercial and savings banks, savings and loanassociations, and credit unions. Travelers checks also are included in the definition oftransactions money. Since $1 in currency and $1 in checkable deposits are freelyconvertible into each other and both can be used directly for expenditures, they aremoney in equal degree. However, only the cash and balances held by the nonbank publicare counted in the money supply. Deposits of the U.S. Treasury, depository institutions,foreign banks and official institutions, as well as vault cash in depository institutions areexcluded.This transactions concept of money is the one designated as M1 in the Federal Reserve'smoney stock statistics. Broader concepts of money (M2 and M3) include M1 as well ascertain other financial assets (such as savings and time deposits at depository institutionsand shares in money market mutual funds) which are relatively liquid but believed torepresent principally investments to their holders rather than media of exchange. Whilefunds can be shifted fairly easily between transaction balances and these other liquidassets, the money-creation process takes place principally through transaction accounts.In the remainder of this booklet, "money" means M1.The distribution between the currency and deposit components of money depends largelyon the preferences of the public. When a depositor cashes a check or makes a cashwithdrawal through an automatic teller machine, he or she reduces the amount of depositsand increases the amount of currency held by the public. Conversely, when people havemore currency than is needed, some is returned to banks in exchange for deposits.While currency is used for a great variety of small transactions, most of the dollar amountof money payments in our economy are made by check or by electronic transfer betweendeposit accounts. Moreover, currency is a relatively small part of the money stock. About69 percent, or $623 billion, of the $898 billion total stock in December 1991, was in theform of transaction deposits, of which $290 billion were demand and $333 billion wereother checkable deposits.What Makes Money Valuable?In the United States neither paper currency nor deposits have value as commodities.Intrinsically, a dollar bill is just a piece of paper, deposits merely book entries. Coins dohave some intrinsic value as metal, but generally far less than their face value.What, then, makes these instruments - checks, paper money, and coins - acceptable atface value in payment of all debts and for other monetary uses? Mainly, it is theconfidence people have that they will be able to exchange such money for other financialassets and for real goods and services whenever they choose to do so.Money, like anything else, derives its value from its scarcity in relation to its usefulness.Commodities or services are more or less valuable because there are more or less of them relative to the amounts people want. Money's usefulness is its unique ability to commandother goods and services and to permit a holder to be constantly ready to do so. Howmuch money is demanded depends on several factors, such as the total volume oftransactions in the economy at any given time, the payments habits of the society, theamount of money that individuals and businesses want to keep on hand to take care ofunexpected transactions, and the forgone earnings of holding financial assets in the formof money rather than some other asset.Control of the quantity of money is essential if its value is to be kept stable. Money's realvalue can be measured only in terms of what it will buy. Therefore, its value variesinversely with the general level of prices. Assuming a constant rate of use, if the volumeof money grows more rapidly than the rate at which the output of real goods and servicesincreases, prices will rise. This will happen because there will be more money than therewill be goods and services to spend it on at prevailing prices. But if, on the other hand,growth in the supply of money does not keep pace with the economy's currentproduction, then prices will fall, the nations's labor force, factories, and other productionfacilities will not be fully employed, or both.Just how large the stock of money needs to be in order to handle the transactions of theeconomy without exerting undue influence on the price level depends on how intensivelymoney is being used. Every transaction deposit balance and every dollar bill is part ofsomebody's spendable funds at any given time, ready to move to other owners astransactions take place. Some holders spend money quickly after they get it, making thesefunds available for other uses. Others, however, hold money for longer periods.Obviously, when some money remains idle, a larger total is needed to accomplish anygiven volume of transactions.Who Creates Money?Changes in the quantity of money may originate with actions of the Federal ReserveSystem (the central bank), depository institutions (principally commercial banks), or thepublic. The major control, however, rests with the central bank.The actual process of money creation takes place primarily in banks.(1) As noted earlier,checkable liabilities of banks are money. These liabilities are customers' accounts. Theyincrease when customers deposit currency and checks and when the proceeds of loansmade by the banks are credited to borrowers' accounts.In the absence of legal reserve requirements, banks can build up deposits by increasingloans and investments so long as they keep enough currency on hand to redeem whateveramounts the holders of deposits want to convert into currency. This unique attribute ofthe banking business was discovered many centuries ago.It started with goldsmiths. As early bankers, they initially provided safekeeping services,making a profit from vault storage fees for gold and coins deposited with them. Peoplewould redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would depositthem for safekeeping, often with the same banker. Everyone soon found that it was a loteasier simply to use the deposit receipts directly as a means of payment. These receipts,which became known as notes, were acceptable as money since whoever held them couldgo to the banker and exchange them for metallic money.Then, bankers discovered that they could make loans merely by giving their promises topay, or bank notes, to borrowers. In this way, banks began to create money. More notescould be issued than the gold and coin on hand because only a portion of the notesoutstanding would be presented for payment at any one time. Enough metallic money hadto be kept on hand, of course, to redeem whatever volume of notes was presented forpayment.Transaction deposits are the modern counterpart of bank notes. It was a small step fromprinting notes to making book entries crediting deposits of borrowers, which theborrowers in turn could "spend" by writing checks, thereby "printing" their own money.What Limits the Amount of Money Banks Can Create?If deposit money can be created so easily, what is to prevent banks from making toomuch - more than sufficient to keep the nation's productive resources fully employedwithout price inflation? Like its predecessor, the modern bank must keep available, tomake payment on demand, a considerable amount of currency and funds on deposit withthe central bank. The bank must be prepared to convert deposit money into currency forthose depositors who request currency. It must make remittance on checks written bydepositors and presented for payment by other banks (settle adverse clearings). Finally, itmust maintain legally required reserves, in the form of vault cash and/or balances at itsFederal Reserve Bank, equal to a prescribed percentage of its deposits.The public's demand for currency varies greatly, but generally follows a seasonal patternthat is quite predictable. The effects on bank funds of these variations in the amount ofcurrency held by the public usually are offset by the central bank, which replaces thereserves absorbed by currency withdrawals from banks. (Just how this is done will beexplained later.) For all banks taken together, there is no net drain of funds throughclearings. A check drawn on one bank normally will be deposited to the credit of anotheraccount, if not in the same bank, then in some other bank.These operating needs influence the minimum amount of reserves an individual bank willhold voluntarily. However, as long as this minimum amount is less than what is legallyrequired, operating needs are of relatively minor importance as a restraint on aggregatedeposit expansion in the banking system. Such expansion cannot continue beyond thepoint where the amount of reserves that all banks have is just sufficient to satisfy legalrequirements under our "fractional reserve" system. For example, if reserves of 20percent were required, deposits could expand only until they were five times as large asreserves. Reserves of $10 million could support deposits of $50 million. The lower thepercentage requirement, the greater the deposit expansion that can be supported by each additional reserve dollar. Thus, the legal reserve ratio together with the dollar amount ofbank reserves are the factors that set the upper limit to money creation.What Are Bank Reserves?Currency held in bank vaults may be counted as legal reserves as well as deposits(reserve balances) at the Federal Reserve Banks. Both are equally acceptable insatisfaction of reserve requirements. A bank can always obtain reserve balances bysending currency to its Reserve Bank and can obtain currency by drawing on its reservebalance. Because either can be used to support a much larger volume of deposit liabilitiesof banks, currency in circulation and reserve balances together are often referred to as"high-powered money" or the "monetary base." Reserve balances and vault cash inbanks, however, are not counted as part of the money stock held by the public.For individual banks, reserve accounts also serve as working balances.(2) Banks mayincrease the balances in their reserve accounts by depositing checks and proceeds fromelectronic funds transfers as well as currency. Or they may draw down these balances bywriting checks on them or by authorizing a debit to them in payment for currency,customers' checks, or other funds transfers.Although reserve accounts are used as working balances, each bank must maintain, onthe average for the relevant reserve maintenance period, reserve balances at their ReserveBank and vault cash which together are equal to its required reserves, as determined bythe amount of its deposits in the reserve computation period.Where Do Bank Reserves Come From?Increases or decreases in bank reserves can result from a number of factors discussedlater in this booklet. From the standpoint of money creation, however, the essential pointis that the reserves of banks are, for the most part, liabilities of the Federal ReserveBanks, and net changes in them are largely determined by actions of the Federal ReserveSystem. Thus, the Federal Reserve, through its ability to vary both the total volume ofreserves and the required ratio of reserves to deposit liabilities, influences banks'decisions with respect to their assets and deposits. One of the major responsibilities of theFederal Reserve System is to provide the total amount of reserves consistent with themonetary needs of the economy at reasonably stable prices. Such actions take intoconsideration, of course, any changes in the pace at which money is being used andchanges in the public's demand for cash balances.The reader should be mindful that deposits and reserves tend to expand simultaneouslyand that the Federal Reserve's control often is exerted through the market place asindividual banks find it either cheaper or more expensive to obtain their requiredreserves, depending on the willingness of the Fed to support the current rate of credit anddeposit expansion. While an individual bank can obtain reserves by bidding them away from other banks,this cannot be done by the banking system as a whole. Except for reserves borrowedtemporarily from the Federal Reserve's discount window, as is shown later, the supply ofreserves in the banking system is controlled by the Federal Reserve.Moreover, a given increase in bank reserves is not necessarily accompanied by anexpansion in money equal to the theoretical potential based on the required ratio ofreserves to deposits. What happens to the quantity of money will vary, depending uponthe reactions of the banks and the public. A number of slippages may occur. Whatamount of reserves will be drained into the public's currency holdings? To what extentwill the increase in total reserves remain unused as excess reserves? How much will beabsorbed by deposits or other liabilities not defined as money but against which banksmight also have to hold reserves? How sensitive are the banks to policy actions of thecentral bank? The significance of these questions will be discussed later in this booklet.The answers indicate why changes in the money supply may be different than expected ormay respond to policy action only after considerable time has elapsed.In the succeeding pages, the effects of various transactions on the quantity of money aredescribed and illustrated. The basic working tool is the "T" account, which provides asimple means of tracing, step by step, the effects of these transactions on both the assetand liability sides of bank balance sheets. Changes in asset items are entered on the lefthalf of the "T" and changes in liabilities on the right half. For any one transaction, ofcourse, there must be at least two entries in order to maintain the equality of assets andliabilities.1In order to describe the money-creation process as simply as possible, the term "bank" used in this booklet should be understood toencompass all depository institutions. Since the Depository Institutions Deregulation and Monetary Control Act of 1980, all depositoryinstitutions have been permitted to offer interest bearing transaction accounts to certain customers. Transaction accounts (interest bearing aswell as demand deposits on which payment of interest is still legally prohibited) at all depository institutions are subject to the reserverequirements set by the Federal Reserve. Thus all such institutions, not just commercial banks, have the potential for creating money. back2Part of an individual bank's reserve account may represent its reserve balance used to meet its reserve requirements while another part may beits required clearing balance on which earnings credits are generated to pay for Federal Reserve Bank services. back Bank Deposits - How They Expand or ContractLet us assume that expansion in the money stock is desired by the Federal Reserve toachieve its policy objectives. One way the central bank can initiate such an expansion isthrough purchases of securities in the open market. Payment for the securities adds tobank reserves. Such purchases (and sales) are called "open market operations."How do open market purchases add to bank reserves and deposits? Suppose the FederalReserve System, through its trading desk at the Federal Reserve Bank of New York, buys$10,000 of Treasury bills from a dealer in U. S. government securities.(3) In today'sworld of computerized financial transactions, the Federal Reserve Bank pays for the securities with an "telectronic" check drawn on itself.(4) Via its "Fedwire" transfernetwork, the Federal Reserve notifies the dealer's designated bank (Bank A) that paymentfor the securities should be credited to (deposited in) the dealer's account at Bank A. Atthe same time, Bank A's reserve account at the Federal Reserve is credited for the amountof the securities purchase. The Federal Reserve System has added $10,000 of securities toits assets, which it has paid for, in effect, by creating a liability on itself in the form ofbank reserve balances. These reserves on Bank A's books are matched by $10,000 of thedealer's deposits that did not exist before. See illustration 1.How the Multiple Expansion Process WorksIf the process ended here, there would be no "multiple" expansion, i.e., deposits and bankreserves would have changed by the same amount. However, banks are required tomaintain reserves equal to only a fraction of their deposits. Reserves in excess of thisamount may be used to increase earning assets - loans and investments. Unused or excessreserves earn no interest. Under current regulations, the reserve requirement against mosttransaction accounts is 10 percent.(5) Assuming, for simplicity, a uniform 10 percentreserve requirement against all transaction deposits, and further assuming that all banksattempt to remain fully invested, we can now trace the process of expansion in depositswhich can take place on the basis of the additional reserves provided by the FederalReserve System's purchase of U. S. government securities.The expansion process may or may not begin with Bank A, depending on what the dealerdoes with the money received from the sale of securities. If the dealer immediately writeschecks for $10,000 and all of them are deposited in other banks, Bank A loses bothdeposits and reserves and shows no net change as a result of the System's open marketpurchase. However, other banks have received them. Most likely, a part of the initialdeposit will remain with Bank A, and a part will be shifted to other banks as the dealer'schecks clear.It does not really matter where this money is at any given time. The important fact is thatthese deposits do not disappear. They are in some deposit accounts at all times. All bankstogether have $10,000 of deposits and reserves that they did not have before. However,they are not required to keep $10,000 of reserves against the $10,000 of deposits. All theyneed to retain, under a 10 percent reserve requirement, is $1000. The remaining $9,000 is"excess reserves." This amount can be loaned or invested. See illustration 2.If business is active, the banks with excess reserves probably will have opportunities toloan the $9,000. Of course, they do not really pay out loans from the money they receiveas deposits. If they did this, no additional money would be created. What they do whenthey make loans is to accept promissory notes in exchange for credits to the borrowers'transaction accounts. Loans (assets) and deposits (liabilities) both rise by $9,000.Reserves are unchanged by the loan transactions. But the deposit credits constitute newadditions to the total deposits of the banking system. See illustration 3. 3Dollar amounts used in the various illustrations do not necessarily bear any resemblance to actual transactions. For example, open marketoperations typically are conducted with many dealers and in amounts totaling several billion dollars. back4Indeed, many transactions today are accomplished through an electronic transfer of funds between accounts rather than through issuance of apaper check. Apart from the time of posting, the accounting entries are the same whether a transfer is made with a paper check orelectronically. The term "check," therefore, is used for both types of transfers. back 5For each bank, the reserve requirement is 3 percent on a specified base amount of transaction accounts and 10 percent on the amount abovethis base. Initially, the Monetary Control Act set this base amount - called the "low reserve tranche" - at $25 million, and provided for it tochange annually in line with the growth in transaction deposits nationally. The low reserve tranche was $41.1 million in 1991 and $42.2 millionin 1992. The Garn-St. Germain Act of 1982 further modified these requirements by exempting the first $2 million of reservable liabilities fromreserve requirements. Like the low reserve tranche, the exempt level is adjusted each year to reflect growth in reservable liabilities. The exemptlevel was $3.4 million in 1991 and $3.6 million in 1992. backDeposit Expansion1. When the Federal Reserve Bank purchases government securities, bank reservesincrease. This happens because the seller of the securities receives payment through acredit to a designated deposit account at a bank (Bank A) which the Federal Reserveeffects by crediting the reserve account of Bank A.FR BANKBANK AAssetsUS govt securities.. +10,000LiabilitiesReserve acct. Bank A.. +10,000 Assets Reserves with FR Banks.. +10,000LiabilitiesCustomer deposit.. +10,000The customer deposit at Bank A likely will be transferred, in part, to other banks andquickly loses its identity amid the huge interbank flow of deposits. back2.As a result, all banks takentogethernow have "excess" reserves on whichdeposit expansion can take place.Total reserves gained from newdeposits.......10,000less: required against new deposits (at 10%)...1,000equals: Excess reserves . . . . . . . . . . . . . . . . . 9,000back Expansion - Stage 13.Expansion takes place only if the banks that hold these excess reserves (Stage 1banks) increase their loans or investments. Loans are made by crediting the borrower'saccount, i.e., by creating additional deposit money. back STAGE 1 BANKSAssetsLiabilities Loans....... +9,000Borrower deposits.... +9,000This is the beginning of the deposit expansion process. In the first stage of the process,total loans and deposits of the banks rise by an amount equal to the excess reservesexisting before any loans were made (90 percent of the initial deposit increase). At theend of Stage 1, deposits have risen a total of $19,000 (the initial $10,000 provided by theFederal Reserve's action plus the $9,000 in deposits created by Stage 1 banks). Seeillustration 4. However, only $900 (10 percent of $9000) of excess reserves have beenabsorbed by the additional deposit growth at Stage 1 banks. See illustration 5.The lending banks, however, do not expect to retain the deposits they create through theirloan operations. Borrowers write checks that probably will be deposited in other banks.As these checks move through the collection process, the Federal Reserve Banks debitthe reserve accounts of the paying banks (Stage 1 banks) and credit those of the receivingbanks. See illustration 6.Whether Stage 1 banks actually do lose the deposits to other banks or whether any or allof the borrowers' checks are redeposited in these same banks makes no difference in theexpansion process. If the lending banks expect to lose these deposits - and an equalamount of reserves - as the borrowers' checks are paid, they will not lend more than theirexcess reserves. Like the original $10,000 deposit, the loan-credited deposits may betransferred to other banks, but they remain somewhere in the banking system. Whicheverbanks receive them also acquire equal amounts of reserves, of which all but 10 percentwill be "excess."Assuming that the banks holding the $9,000 of deposits created in Stage 1 in turn makeloans equal to their excess reserves, then loans and deposits will rise by a further $8,100in the second stage of expansion. This process can continue until deposits have risen tothe point where all the reserves provided by the initial purchase of government securitiesby the Federal Reserve System are just sufficient to satisfy reserve requirements againstthe newly created deposits.(See pages10 and 11.)The individual bank, of course, is not concerned as to the stages of expansion in which itmay be participating. Inflows and outflows of deposits occur continuously. Any depositreceived is new money, regardless of its ultimate source. But if bank policy is to makeloans and investments equal to whatever reserves are in excess of legal requirements, theexpansion process will be carried on.How Much Can Deposits Expand in the Banking System?The total amount of expansion that can take place is illustrated on page 11. Carriedthrough to theoretical limits, the initial $10,000 of reserves distributed within the bankingsystem gives rise to an expansion of $90,000 in bank credit (loans and investments) andsupports a total of $100,000 in new deposits under a 10 percent reserve requirement. The deposit expansion factor for a given amount of new reserves is thus the reciprocal of therequired reserve percentage (1/.10 = 10). Loan expansion will be less by the amount ofthe initial injection. The multiple expansion is possible because the banks as a group arelike one large bank in which checks drawn against borrowers' deposits result in credits toaccounts of other depositors, with no net change in the total reserves.Expansion through Bank InvestmentsDeposit expansion can proceed from investments as well as loans. Suppose that thedemand for loans at some Stage 1 banks is slack. These banks would then probablypurchase securities. If the sellers of the securities were customers, the banks would makepayment by crediting the customers' transaction accounts, deposit liabilities would risejust as if loans had been made. More likely, these banks would purchase the securitiesthrough dealers, paying for them with checks on themselves or on their reserve accounts.These checks would be deposited in the sellers' banks. In either case, the net effects onthe banking system are identical with those resulting from loan operations.4 As a result of the process so far, total assets and total liabilities of all banks togetherhave risen 19,000. backALL BANKSAssetsLiabilitiesReserves with F. R. Banks...+10,000Loans . . . . . . . . . . . . . . . . . + 9,000Total . . . . . . . . . . . . . . . . . +19,000Deposits: Initial. . . .+10,000Stage 1 . . . . . . . . . + 9,000 Total . . . . . . . . . . .+19,0005Excess reserves have been reduced by the amount required against the deposits createdby the loans made in Stage 1. backTotal reserves gained from initial deposits. . . . 10,000less: Required against initial deposits . . . . . . . . -1,000less: Required against Stage 1 requirements . . . . -900 equals: Excess reserves. . . . . . . . . . . . . . . . . . . . 8,100Why do these banks stop increasing their loansand deposits when they still have excess reserves?6 ...because borrowers write checks on their accounts at the lending banks. As thesechecks are deposited in the payees' banks and cleared, the deposits created by Stage 1loans and an equal amount of reserves may be transferred to other banks. back STAGE 1 BANKSAssetsLiabilities Reserves with F. R. Banks . -9000(matched under FR bankliabilities)Borrower deposits . . . -9,000(shown as additions toother bank deposits)FEDERAL RESERVE BANKAssetsLiabilities Reserve accounts: Stage 1 banks .-9,000Other banks. . . . . . . . . . . . . . . . . +9,000OTHER BANKSLiabilities AssetsReserves with F. R. Banks .+9,000Deposits . . . . . . . . . +9,000 Deposit expansion has just begun! Page 10.7Expansion continues as the banks that have excess reserves increase their loans by thatamount, crediting borrowers' deposit accounts in the process, thus creating still moremoney.STAGE 2 BANKSAssetsLiabilities Loans . . . . . . . . + 8100Borrower deposits . . . +8,1008Now the banking system's assets and liabilities have risen by 27,100.ALL BANKSAssetsLiabilities Reserves with F. R. Banks . +10,000Loans: Stage 1 . . . . . . . . . . .+ 9,000Stage 2 . . . . . . . . . . . . . . . . + 8,100Total. . . . . . . . . . . . . . . . . . +27,000 Deposits: Initial . . . . +10,000Stage 1 . . . . . . . . . . . +9,000 Stage 2 . . . . . . . . . . . +8,100Total . . . . . . . . . . . . +27,0009 But there are still 7,290 of excess reserves in the banking system. Total reserves gained from initial deposits . . . . . 10,000less: Required against initial deposits . -1,000less: Required against Stage 1 deposits . -900less: Required against Stage 2 deposits . -810 . . . 2,710equals: Excess reserves . . . . . . . . . . . . . . . . . . . . 7,290 --> to Stage 3 banks10 As borrowers make payments, these reserves will be further dispersed, and theprocess can continue through many more stages, in progressively smaller increments,until the entire 10,000 of reserves have been absorbed by deposit growth. As is apparentfrom the summary table on page 11, more than two-thirds of the deposit expansionpotential is reached after the first ten stages.It should be understood that the stages of expansion occur neither simultaneously nor inthe sequence described above. Some banks use their reserves incompletely or only after aconsiderable time lag, while others expand assets on the basis of expected reservegrowth.The process is, in fact, continuous and may never reach its theoretical limits.End page 10. backPage 11.Thus through stage after stage of expansion,"money" can grow to a total of 10 times the newreserves supplied to the banking system....AssetsReservesLiabilities [] Total(Required)(Excess)Loans andInvestmentsDepositsReservesprovidedExp. Stage 1Stage2Stage 3Stage 4Stage 5Stage 6Stage 7Stage 8Stage 9Stage 1010,0001,0009,000-10,00010,00010,00010,00010,00010,00010,00010,00010,00010,00010,00019002,7103,4394,0954,6865,2175,6956,1266,5136,8628,1007,2906,5615,9055,3144,7834,3053,8743,4873,1389,00017,10024,39030,95136,85642,17046,95351,25855,13258,61919,00027,10034,39040,95146,85652,17056,95361,25865,13268,619 .........Stage 20.........Final Stage.............................................10,0008,9061,09479,05889,058...........................0..................10,00010,00090,000100,000...as the new deposits created by loansat each stage are added to those created at allearlier stages and those supplied by the initialreserve-creating action.End page 11. back Page 12.How Open Market Sales Reduce bank Reserves and DepositsNow suppose some reduction in the amount of money is desired. Normally this wouldreflect temporary or seasonal reductions in activity to be financed since, on a year-to-yearbasis, a growing economy needs at least some monetary expansion. Just as purchases ofgovernment securities by the Federal Reserve System can provide the basis for depositexpansion by adding to bank reserves, sales of securities by the Federal Reserve System reduce the money stock by absorbing bank reserves. The process is essentially the reverseof the expansion steps just described.Suppo...