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Week 9 · Lecture outline

Week 9 — Lecture Outline · Money & the Banking System

Principles of Macroeconomics · ECON 2 Fall 2026 · Prof. Ashford Fictional sample

Course: Principles of Macroeconomics (ECON 2) · Silver Oak University (fictional sample) · Prof. Ashford
Objective 7 — money, banking & monetary policy; the functions of money, fractional-reserve banking, the money multiplier · SLO A & B
Meeting pattern: two 75-min sessions (≈150 min). Segment minutes below total ~150 — scale to your room.

The deck (E), the tutorial (C), and the workshop (P) all teach from this outline. Every number here is pre-computed and independently verified (see the verified box in §4 and _build/logs/week-09-numbers.txt).

Week at a glance
Big question What is money, and how does an ordinary fractional-reserve banking system end up creating more of it?
By week's end students can (1) state the three functions of money and describe M1 vs. M2 qualitatively; (2) explain fractional-reserve banking and trace a T-account through several loan rounds; (3) compute the money multiplier (1/RR) and apply it to a new deposit; (4) state the model's upper-bound caveat (excess reserves; the modern ample-reserves environment).
Key vocabulary medium of exchange, store of value, unit of account, money vs. wealth vs. income, M1, M2, fractional-reserve banking, reserves, required reserves, reserve requirement (RR), excess reserves, T-account, the money multiplier (1/RR), ample reserves
Materials whiteboard; the Week-9 readings/links; a spreadsheet for the deposit-loan rounds; an approved chatbot
Timing note 8 segments ≈ 150 min across two sessions. Trim Segment 7 (interaction) if short on time.

Segment 1 — HOOK: "Where does money actually come from?" (12 min)

Open with a scenario: "You deposit $1,000 in your checking account. The bank doesn't just let it sit in a vault — it lends most of it out to someone else. That borrower deposits it in THEIR bank, which lends most of THAT out too. Question: after this chain runs its course, how much total new money is sloshing around the economy — $1,000, or something bigger?" Let guesses land (some will say "just $1,000," some will guess higher). Then the reveal: "With a 10% reserve requirement, that single $1,000 deposit can support up to $10,000 in new money supply — not because anyone printed anything, but because of ordinary bank lending, chained together. That's today's lecture."

Set the frame: money isn't just paper bills and coins — it's created and destroyed every day through bank lending, a fact most people never think about even though they use money constantly.

Segment 2 — PLAIN-LANGUAGE IDEA: what money IS, and what it is NOT (18 min)

Teach the three functions of money first — the test any object has to pass to count as "money":

1. Medium of exchange — something widely accepted in trade for goods and services (so you don't need a direct "double coincidence of wants" — the seller doesn't have to want exactly what you're offering).
2. Store of value — it holds purchasing power over time (you can hold it today and spend it later without it rotting or evaporating — though inflation, from Week 3, does erode it).
3. Unit of account — a common measuring stick for prices (we quote prices in dollars, not in "how many chickens").

Memory hook: "Money you can SPEND (medium of exchange), SAVE (store of value), and PRICE things IN (unit of account)."

Misconception to name immediately (this is the #1 trap all term): money ≠ wealth, and money ≠ income. Money is a specific asset (cash, checking balances) you can hold; wealth is everything you own minus what you owe (your house, your car, your money, minus your debts); income is a flow — what you earn per period. A billionaire's wealth is mostly stocks and real estate, not stacks of cash — that's wealth, not "money" in the economist's sense.

M1 vs. M2 (qualitative — no arithmetic this week): M1 is the most spendable money — cash in circulation plus checking-account balances (money you can use right now, today, for a transaction). M2 is broader — M1 plus things like savings accounts and small time deposits, which are still money in a real sense but take a small extra step to spend. Think of it as M1 = money you can hand over instantly; M2 = M1 plus money that's one short step away.

Segment 3 — WORKED EXAMPLE #1: fractional-reserve banking, one T-account at a time (25 min)

Set it up on the board and do every step out loud.

The setup. A bank operates under a 10% reserve requirement (RR) — regulators (or the Fed) require it to keep 10% of every deposit on hand as reserves, and it may lend out the rest.

A new customer deposits $1,000 into First Meadowland Bank.

  • Required reserves = 10% of $1,000 = $100 — the bank must keep this on hand.
  • Excess reserves available to lend = $1,000 − $100 = $900 — the bank lends this out (say, as a business loan).
  • That $900 doesn't vanish — the borrower spends it, and it lands as a new deposit at a second bank (Second Meadowland Bank).
  • Second Meadowland Bank keeps 10% of $900 = $90 as required reserves, and lends out the remaining $810.
  • That $810 becomes a new deposit at a third bank, which keeps $81 in reserves and lends out $729. The chain keeps going — each round is 90% of the round before.

✅ VERIFIED NUMBERS (pre-computed; do not recompute)

  • $1,000 deposit, RR = 10%: required reserves $100, first loan $900.
  • Round 2 (the $900 becomes a new deposit): required reserves $90, second loan $810.
  • Round 3 (the $810 becomes a new deposit): required reserves $81, third loan $729.
  • The rounds keep shrinking by a factor of 0.90 each time — a geometric series.

Say it in words (the SLO-A habit): "The bank isn't hoarding your $1,000 — it's keeping the required 10% and pushing the other 90% back into the economy as a loan, which becomes someone else's deposit, and the process repeats." The critical fact for later: banks lend their excess reserves (deposit minus required reserves) — NOT the required reserves, and NOT the whole deposit. This is the single most common student (and chatbot) slip this week.

Segment 4 — THE MONEY MULTIPLIER: summing the whole chain in one formula (25 min)

Rather than tracing every round by hand forever, economists use a shortcut: the money multiplier.

Money multiplier = 1 / RR (where RR is the reserve requirement, expressed as a decimal).

Build the table on the board, live:

Reserve requirement (RR) Money multiplier (1/RR)
10% 1 / 0.10 = 10
20% 1 / 0.20 = 5
5% 1 / 0.05 = 20
25% 1 / 0.25 = 4

Read the pattern out loud: the lower the reserve requirement, the bigger the multiplier — banks keep less on hand, so more gets re-lent at every round, and the chain runs further before it fizzles out. A higher reserve requirement shrinks the multiplier — banks hold back more, less gets re-lent.

Apply it to the anchor scenario: a new $1,000 deposit at RR = 10% can expand the money supply by up to $1,000 × 10 = $10,000 — the same number you'd get by summing the entire infinite geometric chain from Segment 3 (Round 1's $1,000 + $900 + $810 + $729 + … all the way down converges to exactly $10,000).

✅ VERIFIED NUMBERS (pre-computed; do not recompute)

  • Money multiplier at RR = 10%, 20%, 5%, 25% → 10, 5, 20, 4 respectively.
  • $1,000 deposit × multiplier (10 at RR = 10%) = maximum $10,000 money-supply expansion.
  • Geometric-series check: summing every round of the $1,000/RR = 10% chain converges to exactly $10,000 — matches the multiplier shortcut exactly.

THE HONEST CAVEAT (do not skip this — it's load-bearing): 1/RR is an upper bound, not a promise. Two real-world reasons the actual expansion usually falls short:
1. Excess reserves — a bank might choose to hold MORE than the required reserves (extra caution, weak loan demand) instead of lending every available dollar, which slows or stops the chain early.
2. The modern ample-reserves environment — today's Federal Reserve operates with a system where banks already hold reserves well above any required minimum, and the Fed influences rates mainly through interest on reserves (IOR) rather than by tightly constraining lending via a binding reserve requirement (previewed here; built out fully in Week 10). 1/RR is the clean teaching model for how the mechanism WORKS — treat the number it spits out as a ceiling, not a forecast.

Segment 5 — MISCONCEPTIONS + CURES (12 min)

Run these as rapid-fire "true trap or not" calls:

  • "Money and wealth are the same thing." FALSE. Money is one specific asset; wealth is everything owned minus debts.
  • "Banks lend out the REQUIRED reserves." FALSE — backwards. Banks must keep the required reserves; they lend the excess (deposit minus required reserves).
  • "The money multiplier and the spending multiplier (Week 7, 1/(1−MPC)) are the same formula." FALSE — this is the classic mix-up. The money multiplier is 1/RR (banking); the spending multiplier is 1/(1−MPC) (fiscal policy, injected government/consumer spending). Different mechanisms, different inputs, different numbers — don't let them blur together just because both are called "multiplier."
  • "1/RR tells you exactly how much the money supply WILL expand." FALSE. It's the maximum possible expansion, assuming banks lend out every available dollar and no cash is held outside the banking system. Real expansion is typically smaller, because of excess reserves.

Segment 6 — TECHNOLOGY WORKFLOW + AI-CRITIQUE (20 min)

Live demo (spreadsheet): set up three columns — Round, New Deposit, Required Reserve (10%), New Loan — and fill in Rounds 1–4 for the $1,000/RR = 10% chain live, showing the 0.90 shrink each round. This is exactly what the Workshop asks students to build in full.

AI-critique moment (do this with the class): Ask an approved chatbot: "A bank receives a new $1,000 deposit and the reserve requirement is 10%. What is the money multiplier, and what is the maximum possible increase in the money supply? Also, does the bank lend out the required reserves or the excess reserves?" Then audit it together: the right answers are multiplier = 10, maximum expansion = $10,000, and the bank lends the excess reserves ($900), never the required reserves. Chatbots frequently confuse the money multiplier with the spending multiplier (may say 1/(1−0.10) = 1.11, which is wrong here), or say the bank lends the required reserves (backwards), or forget the excess-reserves caveat and present 1/RR as a guaranteed outcome rather than an upper bound. Make the class catch each error and state the correct reasoning. The habit all term: the tool drafts, you judge.

Segment 7 — INTERACTION: mini-debate / classify (12 min)

Pose two classification challenges, thumbs up/down:

  1. "A $50 bill in your wallet and a $50,000 stock portfolio — which one is 'money' in the economist's sense?" Target: only the $50 bill (spendable right now); the stock portfolio is wealth, not money — you'd have to sell it first.
  2. "A bank has a $2,000 deposit and a 25% reserve requirement. How much can it lend?" Target: $2,000 × (1 − 0.25) = $1,500 — the excess reserves, not the full $2,000 and not the $500 in required reserves.

This previews Discussion 9 directly — once students see banks visibly creating spendable money through lending, the fairness/stability question ("should private banks be able to do this?") lands with real weight.

Segment 8 — CALLBACKS, TEASE & THE WEEK'S WORK (10 min)

  • Callback: every example today shared one engine — a bank keeps a fraction of each deposit and lends the rest, and that lending chains through the banking system, expanding the money supply by up to 1/RR times the original deposit.
  • Tease next week: "So who sets that reserve requirement — and who decides whether to make borrowing cheaper or more expensive across the whole economy? Next week: the Federal Reserve — its structure, its tools, and the money market that sets the interest rate."
  • The week's work: Lecture Tutorial (functions of money → M1/M2 → fractional-reserve banking → the money multiplier → the caveat), Practice (6 reps), Quiz 9, Discussion 9, Assignment 9, and Workshop 9 ("How Banks Create Money" — build the deposit-loan rounds in a spreadsheet and compare to 1/RR).

Instructor FAQ — common stumbles

  • "So where does the very FIRST dollar come from?" Great question, and one worth flagging honestly: this week's model starts from an existing $1,000 deposit already in the banking system and traces how lending expands it. Where the underlying monetary base itself comes from (currency issued, the Fed's balance sheet) is Week 10 territory — don't let the class get stuck here; note it's coming and move on.
  • "Isn't the bank just 'creating money out of thin air' — is that legal/safe?" It's the normal, legal mechanism of fractional-reserve banking, regulated by reserve requirements and (in the U.S.) backed by deposit insurance (FDIC) — named factually, no verdict here on whether the system is wise (that's Discussion 9's evenhanded debate).
  • "Money multiplier vs. spending multiplier — I keep mixing them up." Different formulas, different mechanisms: 1/RR = banking/lending chains; 1/(1−MPC) = fiscal-policy spending chains (Week 7). If a question mentions a reserve requirement, it's the money multiplier; if it mentions MPC or government spending, it's the spending multiplier.
  • "Does 1/RR mean the money supply DEFINITELY grows by that much?" No — it's the maximum, assuming banks lend every available dollar. Excess reserves (banks choosing to hold more than required) and the modern ample-reserves operating environment mean the real-world number is typically smaller. Treat 1/RR as a ceiling, not a forecast.
  • "What's the difference between M1 and M2 again?" M1 = the most immediately spendable forms (cash + checking balances). M2 = M1 plus slightly-less-liquid savings (savings accounts, small time deposits) — still money, just one small step from being spent.

~ Prof. Ashford's edition · Fall 2026 · built with thecoursemaker.com