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
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
Money in a checking
account
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