F.5 Economics Deposit Creation
By: Miss Chan Chin Hung, Amy
Sec 1-9-01
The Money Flow in
Simulation Game
rrr = 0.25
Bank A
MARY
$750
LOAN
$1000
Deposits
Bank B
$187.5
JOHN
$750
PAY
Shoe
Seller
$750
Deposits
LOAN
ANN
The above processes repeat through Banks D,E,F… until excess
reserve equals zero.
1st round:
2nd round:
$1000
$750
Increase in deposits after 2 rounds
= ?????
Assumptions





Fractional reserve system
Banks offer demand deposits only
There is no cash leakage
Banks will lend all their excess reserves
There is sufficient demand for bank loans
Fractional reserve system:
a system under which banks are required
to keep a fraction of its deposits as
reserves
Minimum required reserve ratio (rrr):
minimum ratio of reserves to deposits
which banks are required by law to keep
Excess reserves:
Reserves in excess of the required
rrr = 25%
Mary puts $1000 into her account in
Bank A. This is the initial deposits into
the banking system.
Bank A
MARY
$1000
Deposits
PUBLIC
BANK
$1000
PUBLIC
BANK
$1000
PUBLIC
BANK
$750
$1000
$750
PUBLIC
BANK
$750
$1000
$750
PUBLIC
BANK
$562.5
$750
$1000
$750
$562.5
PUBLIC
BANK
$562.5
$750
$1000
$750
$562.5
$421.9
$316.4
.
PUBLIC
.
.
.
$421.9
$562.5
$750
BANK
Round 1
$1000
Round 2
$750
Round 3
$562.5
Round 4
$421.9
Round ……
= $1000 + $750 + $562.5 + …
= $1000 + $1000(0.75) + $1000(0.75)2 + ...
+ $1000(0.75)n-1
= $1000/(1-0.75)
= $1000 x 0.25
= $4000
Total Deposits Created
1

 $1000
1  0.75
1

 $1000
0.25
1

 initial deposits
rrr
=
Banking multiplier x initial deposits
In our example,
Mary deposits $1000 into her account
rrr = 0.25
Banking multiplier = 1/0.25 = 4
Total Deposits Created
= $1000 x 4
= $4000
1.
Bank E’s balance sheet:
Assets
Liabilities
Total Reserves
$4000
Loan
$5000
Deposits
$9000
Suppose the minimum required reserve ratio is 0.2.
Find Bank E’s excess reserves after Peter deposits
$2000 into his account in Bank E.
Bank E’s balance sheet after Peter’s deposit of $2000:
Assets
Liabilities
Total Reserves
$6000 Deposits
Loan
$5000
$11000
Required Reserves = $11000 x 0.2 = $2200
Excess Reserves = $6000 - $2200 = $3800
2.
At r = 0.2 , what is the maximum amount
of deposits created by the banking
system?
Maximum deposits created
= $2000 x banking multiplier
= $2000 x 1/0.2
= $2000 x 5
= $10000
1
Bank multiplier =
Required reserve ratio
Total deposit increment
= initial deposit x banking multiplier