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Now, First National must hold only 10% as required reserves ($900,000) but can lend out the other 90% ($8.1 million) in a loan to Jack’s Chevy Dealership as shown in [link] .

First national balance sheet

 The assets are reserves ($90,000) and loans ($8.1 million). The liabilities + net worth are deposits (+ $9 million).

If Jack’s deposits the loan in its checking account at Second National, the money supply just increased by an additional $8.1 million, as [link] shows.

Second national bank’s balance sheet

 The assets are reserves (+ $8.1 million). The liabilities + net worth are deposits (+ $8.1 million).

How is this money creation possible? It is possible because there are multiple banks in the financial system, they are required to hold only a fraction of their deposits, and loans end up deposited in other banks, which increases deposits and, in essence, the money supply.

Watch this video to learn more about how banks create money.

The money multiplier and a multi-bank system

In a system with multiple banks, the initial excess reserve amount that Singleton Bank decided to lend to Hank’s Auto Supply was deposited into Frist National Bank, which is free to loan out $8.1 million. If all banks loan out their excess reserves, the money supply will expand. In a multi-bank system, the amount of money that the system can create is found by using the money multiplier. The money multiplier tells us by how many times a loan will be “multiplied” as it is spent in the economy and then re-deposited in other banks.

Fortunately, a formula exists for calculating the total of these many rounds of lending in a banking system. The money multiplier formula    is:

1 Reserve Requirement

The money multiplier is then multiplied by the change in excess reserves to determine the total amount of M1 money supply created in the banking system. See the Work it Out feature to walk through the multiplier calculation.

Using the money multiplier formula

Using the money multiplier for the example in this text:

Step 1. In the case of Singleton Bank, for whom the reserve requirement is 10% (or 0.10), the money multiplier is 1 divided by .10, which is equal to 10.

Step 2. We have identified that the excess reserves are $9 million, so, using the formula we can determine the total change in the M1 money supply:

Total Change in the M1 Money Supply = 1 Reserve Requirement  ×  Excess Requirement = 1 0.10  ×  $9  million = 10  ×  $9  million = $90  million

Step 3. Thus, we can say that, in this example, the total quantity of money generated in this economy after all rounds of lending are completed will be $90 million.

Cautions about the money multiplier

The money multiplier will depend on the proportion of reserves that banks are required to hold by the Federal Reserve Bank. Additionally, a bank can also choose to hold extra reserves. Banks may decide to vary how much they hold in reserves for two reasons: macroeconomic conditions and government rules. When an economy is in recession, banks are likely to hold a higher proportion of reserves because they fear that loans are less likely to be repaid when the economy is slow. The Federal Reserve may also raise or lower the required reserves held by banks as a policy move to affect the quantity of money in an economy, as Monetary Policy and Bank Regulation will discuss.

Questions & Answers

what is price determination?
Alick Reply
why are imports subtructed when GDP is calculated in the expenditure approach
what is fiscalpolicy
nati Reply
The way of the government expenses and other analysis
It explains government spending and how it helps to direct the economy towards the desired direction. For instance, if the govt of a nation is desirous of achieving economic growth and development, then the govt will adopt an expansionary fiscal policy which imply more spending by the govt.
and politics party important
mujtaba Reply
politics party important
Which party is that
persons who stopped searching for jobs but would accept if the opportunity presents itself
Torissa Reply
persons who are unemployed whether they are underage, retired or incapacitated
the us economy is best characterized as?
what is the impact of fiscal policy in the short and long run in the AD/AS model...
Hydrammeh Reply
What is demand
Mohd Reply
Demand is the desire for a commodity backed by the willingness and the purchasing power too.
what is the impact of the higher tax rate on the business and the economy at large..?
Hydrammeh Reply
aggregate demand decreases and GDP decreases in the long run prices will decrease because aggregate supply will shift to the right and increase
Thanks, Murabit
But still I will need more explanation
no problem tax rate is a form of fiscal policy so any time the government changes spending or taxes it will directly affect the economy
but remember that there at different economic views on fiscal policy there is classical,Keynesian and moneterism
if taxes increase aggregate demand decreases causing a fall in prices causing a fall in the money demand lowering interest rate and increasing investment spending in turn increasing prices
thanks so much Murabit
what are the policy recommendations for impact of government borrowing?
Baisiro Reply
how can I get Utility notes here
Tabea Reply
I also want to know
I have them
money and money supply
Yogesh Reply
money is anything that is generally accepted as payment of goods and services or that is accepted in settlement of debt.
Money supply?
Money supply is the total value of monetary assets available in an economy at a specific time.
supply of money:- The total quantity of money in an economy at a point of time......
What is the difference between monetary economy and barter economy?
monetary economy is simply an economy where money acts as a medium of exchange and barter economy is why where goods acts as a medium of exchange
Thank you Ittoo.
please cut why.....in last ans
and no need of thanks dear
Don't damend work in inflation
Mishael Reply
conceptand variable of macro economics
Bittu Reply
macro economics is the study of general factors in an economy.
what is fiscal policy?
fiscal policy refers to the use of government spending,taxation and borrowing to affect economic activity ,monetary policy on the other hand, entails the manipulation of interest rates.
A lots of thanks
you are welcome
Very informative talukder
yes Jafta
So scarcity will always be a problem, is something that can't be solved due to specialization of labor and choice?
yes right Jafta
good definition Jata♥♥
how are you all
Kindly explain or give example of Voluntary unemployment.
when unemployment doesn't choose a accept job at wage of rate
Thanks Talukder
macroeconomics is not too hard
wow Omar, ur so helpful lol🤣
good ho every one
what's up guys■■
I want someone to tell me everything about the inflation and and hyber inflation is plz
hi someone to explain to mi notes ov money and banking
dia explain to me notes of money and banking
dot US Army higher South Korean citizen for the US base South Korea and pay them 50000 as a result
farzana Reply
What is production possibility frontier
adewale Reply
Production possibility frontier is a curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors. The production possibility curve is frontir that all inputs are used efficiently.
what are some examples of a monetary policy?
Viccey Reply
expansionary policy contractionary policy

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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