“The process by which banks create money is so simple that the mind is repelled.” John Kenneth Galbraith My favorite economist. Money Creation. Chapter Objectives. Why the U.S. Banking System is Called a “Fractional Reserve” System
Why the U.S. Banking System is Called a “Fractional Reserve” System
Distinction Between a Bank’s Actual Reserves and Its Required Reserves
How a Bank Can Create Money Through Granting Loans
The Multiple Expansion of Loans and Money by the Entire Banking System
The Monetary Multiplier and How to Calculate it
Banks are required to keep a certain percentage of checking account balances on hand in their vault or in their account at the Federal Reserve Bank.
The reserve requirement is a percentage established by the Federal Reserve.
What banks have in vaults and accounts at Fed.
What banks are required to have in vaults and Fed accounts.
Amount that banks can loan out.
Excess Reserves = Loanable Funds
Injection into the money supply by the Federal Reserve Bank
With fractional reserve banking, the initial injection into the banking system has a multiplier effect on the money supply.
Amount of the impact depends on the reserve requirement.
Money (deposit) multiplier = reciprocal of reserve requirement
If reserve requirement is 10%, money multiplier = 1/0.10 = 10
Deposit of $100,000 can increase the money supply by
10 x $100,000 = $1 million
If reserve requirement is 5%, money multiplier =
1/0.05 = 20
Deposit of $100,000 can impact the money supply by
20 x $100,000 = $2 million
Required Reserve Ratio
RThe Monetary MultiplierOr Checkable Deposit Multiplier
Suppose the required reserve ration is 20%
Before Deposit Insurance (FDIC)
More than 9,000 banks failed in one year
Resulted in FDIC and 25% Drop in Money Supply
Regulation Protects the System Today (your author said this, not me!)
fractional reserve banking system
Banks Create Money
Fractional Reserve Banking
Amount of Change in the Money Supply
Excess Reserves Are Loanable
Money (Deposit) Multiplier