The Money Multiplier and Taccounts The Money Multiplier

The Money Multiplier and T-accounts

The Money Multiplier Suppose that Narvaiz National Bank opens and it is a depository only institution – it accepts deposits but does not make loans -- this means it is a 100% reserve bank The T-account below shows the changes in Narvaiz National Bank if $1, 000 is deposited • On the left side are its assets of $1000 (the reserves it holds) • On the right side are the liabilities of $1, 000 (the amount it owes to its depositors). Narvaiz National Bank _____Assets__________Liabilities_____ Reserves $1000 Deposits $1, 000

Change to a Fractional System • Suppose Narvaiz National Bank adopts a fractional reserve banking system. • The required reserve ratio is 1/10 or 10%. • Complete the T-account below representing this change. Narvaiz National Bank _____Assets__________Liabilities_____ Required Reserves $100 Excess Reserves $900 Deposits $1, 000 Narvaiz National Ba nk

Let’s Make a Loan • Leaving all the money idle seems unnecessary. • Narvaiz National Bank decides to lend out its excess reserves • Complete the T-account below representing this change. Narvaiz National Bank _____Assets__________Liabilities_____ Required Reserves $100 Excess Reserves $0 Loans $900 Narvaiz Bank will loan you $900 Deposits $1, 000

Deposit the Loan • • • Suppose the person who borrows the $900 uses it to buy a car. The car dealer also does business with Narvaiz National Bank. The dealer deposits the entire $900 from the sale of the car in the bank. Remember the bank will have to keep 10% of the $900 as required reserves Complete the T-account showing the change that will result from this $900 deposit Narvaiz National Bank _____Assets__________Liabilities_____ $190 Required Reserves $100 $810 Excess Reserves $0 Loans $900 $1, 900 Deposits $1, 000 That guy just bought a car from me. I’m going to deposit the $900 from that sale

Narvaiz National Bank now has excess reserves of $810. What should the bank do to maximize profits? Narvaiz National Bank _____Assets__________Liabilities_____ Required Reserves $190 Excess Reserves $810 Loans $900 Deposits $1, 900

Let’s Make Another Loan • Suppose the bank decides to lend out its excess reserves. • Complete the T-account below showing the change that will result when excess reserves are converted to loans. Narvaiz National Bank _____Assets__________Liabilities_____ Required Reserves $190 Excess Reserves $810 $0 Loans $1, 710 $900 Deposits $1, 900 Narvaiz National Bank just gave me an $810 loan

Deposit the Loan • • • Suppose the person who borrows the $810 uses it to buy a fridge. The appliance store also does business with Narvaiz National Bank. The store deposits the entire $810 from the sale of the fridge in the bank. Remember the bank will have to keep 10% of the $810 as required reserves Complete the T-account showing the change that will result from this $8100 deposit Narvaiz National Bank _____Assets__________Liabilities_____ $190 Required Reserves $271 $729 Excess Reserves $0 Loans $1710 $1, 900 Deposits $2, 710 $810

The Money Multiplier = ____1_____ Reserve requirements Money multiplier X excess reserves = increase in the money supply • For this example the money multiplier is __1__. 10 = 10 • The excess reserves that started the multiplier process were $900 • The money supply increased by 10 x $900 = $9, 000

HOWEVER, bank deposits originally increased by $1, 000 plus the $9000 created by the multiplier for a total change in bank deposits of $10, 000

Let’s play Is it in the Money Supply?

Cash in your pocket y l p In e th o m p u s y e n

Money in a checking account y l p In e th o m p u s y e n

Total Change • Assume that all the money created in the example is deposited in Narvaiz National Bank • ALSO assume that the bank will loan out all of the excess reserves • Complete the T-account showing the end result of these transactions Narvaiz National Bank _____Assets__________Liabilities_____ Required Reserves $1, 000 Excess Reserves $0 Loans $9, 000 Deposits $10, 000 Narvaiz National Ba nk