APMacro: Multiple Expansion Checkable Deposits


A single bank in a banking system can lend one dollar for each dollar of its excess reserves. The commercial banking system can lend, that is, can create money, by a multiple of its excess reserves.

A1 Multiple Deposit Expansion
Suppose a person finds a $100 and deposits the $100 in bank A, which adds the $100 to its reserves. Of the newly acquired $100 in currency, 20 percent, or $20 must be earmarked for required reserves on the new $100 checkable deposit, and the remaining $80 goes to excess reserves. A single bank can lend only an amount equal to its excess reserves, therefore bank A can lend a maximum of $80.

A2a Multiple Deposit Expansion
When a loan for this amount is made, bank A’s loans increase by $80 and the borrower gets an $80 checkable deposit.

A2b Multiple Deposit Expansion
We add these figures to bank A’s balance sheet.

A3 Multiple Deposit Expansion
The borrower draws a check for the entire amount of the loan ($80) and gives it to someone who deposits it in bank B, a different bank. Bank A loses both reserves and deposits equal to the amount of the loan. The net results of these transactions is that bank A’s reserves now stand at ($100 – $80 = )$20, loans at $80, and checkable deposits at ($180 – $80 =) $100. Bank A is just meeting the 20 percent reserve ratio.

B1 Multiple Deposit Expansion
Bank B acquires the reserves and the deposits that bank A has lost. When the borrower’s check is drawn and cleared, bank A loses $80 in reserves and deposits and bank B gains $80 in reserves and deposits.

B2a Multiple Deposit Expansion
But 20 percent or $16 of bank B’s new reserves must be kept as required reserves against the new $80 in checkable deposits. This means that bank B has ($80 – $16 =)$64 in excess reserves. It can therefore lend $64 to a new borrower

B2b Multiple Deposit Expansion
We add these figures to bank B’s balance sheet.

B3 Multiple Deposit Expansion
The new borrower draws a check for the entire amount of the loan and deposits it in bank C. The reserves and deposits of bank B fall by $64. As a result of these transactions bank B’s reserves now stand at ($80 – $64 =)$16, loans at $64, and checkable deposits at ($144 – $64 =)$80. After all this, bank B is just meeting the 20 percent reserve requirement.

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On the basis of only $80 in excess reserves, acquired by the banking system when someone deposited $100 of currency in bank A, the entire banking system is able to lend $400. The banking system can lend excess reserves by a multiple of 5 when the reserve ratio is 20 percent.

The banking system magnifies any original excess reserves into a larger amount of newly created checkable deposit money. The money multiplier is similar in concept to the spending multiplier. The money multiplier exists because the reserves and deposits lost by one bank becomes reserves of another bank. It magnifies excess reserves into a larger creation of checkable deposit money.

Money multiplier = 1 / required reserve ratio

By multiplying the excess reserves by the money multiplier, we can find the maximum amount of new checkable deposit money that can be created by the banking system.

Maximum checkable deposit creation = excess reserves X money multiplier

The process we have described is reversible. Just as checkable deposit money is created when banks make loans, checkable deposit money is destroyed when loans are paid off. Loan repayment sets off a process of multiple destruction of money the opposite of the multiple creation process. Because loans are both made and paid off in any period, the direction of the loans, checkable deposits, and money supply in a given period will depend on the net effect of the two processes. If the dollar amount of loans made in some period exceeds the dollar amount of loans paid off, checkable deposits will expand and the money supply will increase. But if the dollar amount of loans is less than the dollar amount of loans paid off, checkable deposits will contract and the money supply will decrease.


Homework:
1) Read Chapter 13 pp.245-254.  Answer questions #1, 2, 4, 5, 6, 7, 8, 9, 10, 12, 13
2) Learnerator: Demand & Supply Equilibrium #1-24, Macroeconomic issues #1-15

Arrows-02-june

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