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Money Mechanism

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  • April 2012
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Modern Money Mechanics

A Workbook on Bank Reserves and Deposit Expansion

Federal Reserve Bank of Chicago

Modern Money Mechanics
The purpose of this booklet is to desmmbe basic the process of money creation in a ~actional reserve" banking system. l7ze approach taken illustrates the changes in bank balance sheets that occur when deposits in banks change as a result of monetary action by the Federal Reserve System -the central bank of the United States. The relationshipsshown are based on simplil5ring assumptions. For the sake of simplicity, the relationships are shown as if they were mechanical, but they are not, as is described later in the booklet. Thus, they should not be intwreted to imply a close and predictable relationship between a specific central bank transaction and the quantity of money. The introductorypages contain a briefgeneral desm'ption of the characte*ics of money and how the US. money system works. m e illustrations in thefbllowing two sections describe two processes: fijirst, how bank akposits expand or contract in response to changes in the amount of reserves supplied by the centml bank; and second, how those reserves are afected by both Federal Reserve actions and otherjizctm. A final section deals with some of the elements that modifi, at least i~the short Tun, the simple mechanical relationship between bank reserves and deposit money. Money is such a routine part of everyday living that its existence and acceptance ordinarily are taken for granted. A user may sense that money must come into being either automatically as a result of economic activity or as an outgrowth of some government operation. But just how this happens all too often remains a mystery. What Is Money? I money is viewed simply as a tool used to facilitate f transactions, only those media that are readily accepted in exchange for goods, services, and other assets need to be considered. Many things -from stones to baseball cards -have served this monetary function...

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