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And finance Allah shmoop What our reserve requirements excess reserves

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and the multiple expansion of deposits in the US The

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Fed a k a The Federal Reserve a k a

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The central bank keeps a watchful eye on reserve banks

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who keep a watchful eye on commercial banks So yes

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there's a whole hierarchy If the Fed is like a

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royal family well then reserve banks or dukes and duchesses

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and the commercial banks are aristocrats The Fed requires banks

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to meet reserve requirements also known as the cash reserve

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ratio which is the amount of money banks have to

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keep on hand Handy Dandy Ready for quick withdrawal Why

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is this a rule Well part of what spawned the

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Fed into existence in the first place was a siri's

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of runs on banks from banking panics A run on

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the bank is when everyone rushes to their bank and

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demands all of their deposits back Now the thing is

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one of the boys banks make money is by lending

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out your money to other people Yep your money Your

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deposit for banks to make the most money possible Well

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they would lend out as much money as they could

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which in theory would be all of it But then

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that leaves you the deposit or without cash when you

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need it The Fed wanted runs on banks to be

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a thing of the past which they pretty much are

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now so they made these reserve requirements The money that

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banks are allowed to loan out are called the excess

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reserve For instance a bank may be required to have

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say ten percent of its total money on hand which

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would mean the remaining ninety per cent of the money

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is excess reserves which banks can lend out to turn

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a profit Now here's where the magic happens Multiple expansion

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of deposit Well multiple expansion of deposits is the theory

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that each deposit into a bank creates additional money made

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from excess reserve deposit as they are well continuously lent

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out by banks and then re deposited in other banks

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There's a literal multiplier effect that ripples outward into the

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economy called the Deposit Expansion Multi a buyer which estimates

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the maximum amount of money that the Fed could expect

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in deposit injection into the economic system that you know

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they were kind of creating and managing Well this is

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how the Fed the controller of the money supply decides

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how much new money toe pump into the economy and

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the maximum effect they could possibly expect from that injection

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of money into the system For instance let's say your

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bank has a ten percent reserve requirement leaving ninety percent

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in excess reserves Well when that money is lent out

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whether to a consumer or a business it's deposited into

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another bank eventually So let's say you deposited two thousand

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dollars check into your bank account in your bank says

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would be and it lends out ninety percent of it

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which is eighteen hundred box right that other two hundred

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dollars they were going to keep on hand for reserve

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requirements Okay so let's say that eighteen hundred dollars is

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linked to a climber Chris who's keen on climbing Mount

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Everest climber Chris deposits that eighteen hundred dollars into his

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bank account Clymer Chris's bank says would be just like

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your bank and they do the same thing that bank

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lens Ninety percent of the eighteen hundred dollars which is

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sixteen hundred twenty bucks The remaining ten percent that hundred

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eighty is kept at Climber Chris's Bank to meet reserve

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requirements Well Climate Chris Bank then lends out six hundred

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twenty dollars to teacher Tina who's running short on school

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supplies and gas Teacher Tina What's that Sixteen twenty into

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her bank account And you can guess what teacher Tina's

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bank account does Yep same is your bank and same

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as Climber Chris's bank and teacher Tina's bank lends out

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ninety percent of the money she deposit which is a

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fourteen hundred forty eight dollars to Dan the Man and

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so on Under this system and initial deposit actually grows

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providing more value than the initial amount deposited Its multiplied

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each time money is loaned out and then re deposited

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only ninety percent That deposit gets turned into a new

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loan Well we could keep taking ninety percent of the

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deposits The maximum amount thanks can loan out from that

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deposit until the amount loaned out deposited gets just any

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words No more counting anymore So you still have that

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two thousand dollars in your bank account that belongs to

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you Meanwhile climate Chris has eighteen hundred and you can

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spend a teacher Tina has sixteen twenty that she can

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spend and it all came from your initial deposit Thank

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you very much Well how Khun to Grand that was

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in your bank account multiply into additional value that other

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people can use in the economy But we told you

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that multiple expansions of deposits was magic It literally expands

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the money supply Will remember that deposit expansion multiplier we

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mentioned earlier It's how the Fed can measure the maximum

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amount of money and initial injection of a deposit like

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your two grand can be expected to create Will the

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deposit expansion multipliers just calculated as one divided by the

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reserve requirements sonar case That's one By the by point

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one or ten we can use the deposit expansion multiplier

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to see how much money you're too grand Deposit expanded

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the money supply under this setting to figure out how

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much a deposit expanding the money supply We just multiply

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the expansion multiplier by the initial excess reserves On our

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scenario the reserve requirements ten percent which gives a deposit

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expansion multiplier of ten Then we take that excess reserves

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from the initial deposit You know that ninety percent chunk

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of money that was created into the first loan for

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climate Chris by your bank and I was eighteen hundred

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bucks right So you're going to multiply that eighteen hundred

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by ten So ninety percent ofyour deposit was loaned out

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on deposit to Climate Chris and I sounded out blown

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out positive Tina and I pretended I was loaned out

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and positive Dan the Man and so on So if

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we assume the bank's loaned out ninety percent of stage

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while then it means the money supply was expanded by

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eighteen thousand dollars That means assuming a reserve requirement of

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ten percent for all commercial banks while your initial deposit

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of two grand expanded the money supply nine times to

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be eighteen thousand dollars in the economy Yes you Khun

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tell everyone you're welcome Okay So besides feeling likea money

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expansion superhero why do we care about multiple expansion of

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deposits Well the Fed is in charge of keeping the

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economy healthy One major way of doing that is by

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maintaining the money supply you can think about That is

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a doctor and the economy is a patient with the

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money Supply is well the blood pressure A low blood

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pressure like a low money supply means multiple expansion of

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deposit is low which means there's less money flowing through

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the economy which results in less spending and slower economic

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growth Yeah no likey Blood pressure that's too high like

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a high money supply isn't good either though we've seen

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it before in history where a government just starts printing

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more and more money without the corresponding economic growth and

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what happens well hyperinflation prices of everything skyrocket and money

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becomes almost useless People lose trust in the system And

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oh that's so not good for the economy So that

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two dollar milk and now it's one hundred dollars a

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carton a month later Six thousand Some places have faced

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hyperinflation of like three thousand percent a year or more

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Well the feds jobs to keep the economy's money supply

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like blood pressure stable which means it needs to be

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not too high not too low Well when the Fed

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raises interest rates it essentially lowers the demand for loans

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It lowers the amount of access reserve loaned out and

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that whole process slows the growth of the money supply

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from slower expansions of deposits When the Fed lowers interest

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rates it's trying to increase demand for loans encouraging the

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multiple expansion of deposits to grow the money supply well

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Besides interest rates the Fed can tinker with things like

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stimulus packages and other strategies to expand or contract the

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money supply They do all kinds of things They're sort

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of crazy All right so now you know money does

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not grow on trees but well it does grow out

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of your bank account So let's go deposits him though

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