StellarExpansion of Money Supply Through Bank Loans
When banks make loans, they effectively create new money in the economy. This is because more and more loans can be made from a single loan.
For example, suppose a person deposits 1,000 dollars into their bank account. If the reserve requirement is 10 dollars, the bank must keep 100 dollars as reserves, but they will lend out 900 dollars. As this 900 dollars is loaned out and deposited into another bank, 10% of the 900 dollars is kept as reserves, with the other 810 dollars loaned out into another bank. The process continues, until no more money can be loaned out. This is the logic behind creating new money.
The money multiplier is a factor that determines how much the money supply will increase based on an initial deposit and the reserve requirement. It reflects the amount of money that banks can create with each dollar of reserves. The money multiplier (MM) is calculated as:
Where the required reserve ratio is the ratio of reserves that is required by the government.
For example, suppose a person deposits 1,000 dollars into their bank account. If the reserve requirement is 10 dollars, the bank must keep 100 dollars as reserves, but they will lend out 900 dollars. As this 900 dollars is loaned out and deposited into another bank, 10% of the 900 dollars is kept as reserves, with the other 810 dollars loaned out into another bank. The process continues, until no more money can be loaned out. This is the logic behind creating new money.
The money multiplier is a factor that determines how much the money supply will increase based on an initial deposit and the reserve requirement. It reflects the amount of money that banks can create with each dollar of reserves. The money multiplier (MM) is calculated as: