1. Money! The Money Multiplier

2. How banks create money Fractional Reserves You deposit some currency
Banks do not hang on to all of your deposits
They need to use them to make a profit
You deposit some currency
Bank holds on to some of it: “Reserves”
Bank loans the rest out.
Those loans turn into currency
People buy stuff with borrowed money.
The borrowed money goes into circulation…

3. How banks create money:
Currency in Circulation
Reserves
Demand Deposits
MONEY SUPPLY
Step 1: People have cash
$1,000 $0
Step 2: People deposit cash in bank.
Step 3: Bank sets aside reserves + loans out the rest
$900
$100
$1,900
Step 4: People spend their loans on stuff/ Merchants deposit their earnings into the bank.
Step 5: Same as #3
$810
$190
$2,710

4. That’s how banks create money.
Now… how much do they create?

5. The Money Multiplier Basic Theory: Given a Reserve Ratio of 10%
$500 turns into….
$5,000
Assuming a perfect, bank-deposit-only world.
Checkable deposits ÷ Reserve ratio.
What would a reserve ratio of 20% do?
$500 turns into
$2,500…
The bank has to hold on to more.

6. Real life isn’t quite that simple.
Where could money leak out of this system?
People carry money in their wallets
Not 100% of every loan goes to a merchant
Sales tax
Money leaves the GDP…
Banks can hold excess reserves

7. The money supply depends on
Currency
How much people choose to hold vs. spend
How much currency is in circulation
Bank deposits
How much banks hold excess reserves
The Federal Reserve sets required reserve ratios
Link: - table1
Anything more the bank wants to hold = excess
Normal times, they don’t want these…

8. Subtle difference that’s important now
Monetary Base
Fed can control:
Currency in circulation, plus
Reserves held by banks
Money Supply
Created by the market:
Checkable Bank Deposits (aka Demand Deposits)

9. Monetary Base vs. Money Supply

10. What’s the real money multiplier?
Ratio of the money supply to the monetary base.
In the U.S., it used to be ~1.9
So, every dollar of bank reserves supports $1.90 of money supply.