<< Chapter < Page Chapter >> Page >

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

this means that the demand curve have negative relationship with the price ..which means that when high price low demand of the product and vice versa so higher price will shirnk the demand of product
Ahsan Reply
a person has 60birr to buy two commodities,x and y the price of x is four birr unit the price of y is two birr unit his utility functio given by u=xy+2x determine the budget equation
Mohammed Reply
What are the various reasons for the Federal Reserve to increase the fed rates?
What is unemployment
Mijash Reply
Unemployment is a term used to describe people who do not hold a paying job
what are the causes of unemployment
unemployment refer to the situation in which people searching job but they have no. it also refers in which marginal productivity in zero.
Causes of unemployment are: 1: Over Population 2: Break down of the family system 3: Rural/Urban Migration
unemployment simply means, in the situation where by people are looking for a job and their could achieve it.
suppose you're the economist of ethiopia; when the country is face high rate of inflation what you recommend as one economist?
Roba Reply
if consumer spend all their incomes on consumption what does it mean?
if the government spends more of its revenue on development infrastructure from the budget it have and lower tax collection the budget deficit will run why?
because tax is less than revenue
what is demand
Sunday Reply
Demand is the quantity of goods and services that consumers are willing and able to purchase at various prices over a given period of time
the total value of goods and services produced by a coutry in it's own territorial area( mainly in a year) is called GDP
fareeha Reply
GDP- the total value of goods produced and services provided in a country during one year.
What is the formula for propensity to save
there is no formula for propensity to save but it has a two types one is average propensity to save and marginal propensity to save where Apc is equal to saving divide by income and mpc is equal to change in saving due change in income
yes ooo
what is time in economics?
what is gross domestic product
Moonga Reply
what is macroeconomics
Dickison Reply
what is macroeconomics
Majid Reply
what is macroeconomic analysis
Deogratius Reply
Macroeconomics is a branch of the economics that studies how the aggregate economy behaves. In macroeconomics, a variety of economy-wide phenomena is thoroughly examined such as inflation, price levels, rate of growth, national income, gross domestic product (GDP) and changes in unemployment Read m
Macroeconomics is a branch of the economics that studies how the aggregate economy behaves. In macroeconomics, a variety of economy-wide phenomena is thoroughly examined such as inflation, price levels, rate of growth, national income, gross domestic product (GDP) and changes in unemployment
what is wage in economics?
what is economic
Wajeed Reply
Economics is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. 
Economics is the brench of science that deals with the study of human behavior as it related to end or scare means which have alternative used.
Economics is a science that studies human behavior as a relationship between ends and scarce means which have alternative uses
Economics as a social science does not have a definite definition, because it has been defined by many economist the most appropriate one was the one defined by Lord Lionel Robbin in 1932. He defined economics as a social science which study human behavior as a relationship between end and scare m..
what is inflation
Junaid Reply
Inflation is simply a situation in an economy where there is a persistent rise or increase in the prices of goods and services in a particular year(say current year)
It can still be defined as a situation in an economy where there's a persistent fall in the value of money
it is the persistent rise in the general price of goods and services in an economy leading to the fall in the values of money
It could mean the central bank has a deficit in reserve unable to cope with low export and exit of foreign investments.
inflation is the general increase in a commodity with in a country.
Mr Fallah please take the definition again that one is not clear
the persistence in general price of commodities
The persistence rise in the general price level
The persistence rise in general price of commodities
Inflation is the persistent increase in price of goods and services over a given period of time.
what is willingness
Bilal Reply
Is a person Able,Capable and Anxious to something
Is when a person is able,capable and Anxious to do something
thanks sir g.
u are welcome
where you from
And you
How far are you in Education
who about my question What is MPC
is marginal propensity to consume
a little more
sorry muafue sir you are little bit wrong about willingness *willingness reffers how much wants . it could be wants for payment or wants for something to do.
MPC reffers *How much want to consume*.
MPC is Marginal Propensity to Consume. MPC is proportion of additional spent on consumption.
MPC is Marginal Propensity to Consume. MPC is the proportion of additional income spent on consumption.
What is difference between GNP and GDP?
GNP is gross national product. In calculating GNP we include net national income from abroad while GDP is gross domestic product and in calculating it we use on expenditure, income and output from within the country. My name is JERRY NGONDA from Cameron
GNP.the total value of good $service currently produce w a given period of time by domestic owner GNP=NFI+GDP:GDP is a market value of final good $service currently produce in a given period of time w in a country boundery or territors.its take produce currently $etc
yes.no suggestions
good Tade Feyera
Tade Feyera can you send me your whatsap contact number.
when spending by the federal government exceeds net taxes?
stefany Reply
explain the difference between macroeconomics and microeconomics
Macroeconomics is the study of economics at the aggregate level while Micro is at the individual level.
Both indifference curve and isoquant do not intersect TRUE OR FALSE and justify your statement
what is long run and short run period

Get the best Macroeconomics course in your pocket!

Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Macroeconomics' conversation and receive update notifications?