Banking and the Expansion of the Money Supply
| English | Chinese | Pinyin |
|---|---|---|
| deposit | 存款 | cún kuǎn |
| fractional reserve banking | 部分准备金银行制度 | bù fèn zhǔn bèi jīn yín háng zhì dù |
| required reserves | 法定准备金 | fǎ dìng zhǔn bèi jīn |
| reserve ratio | 准备金率 | zhǔn bèi jīn lǜ |
| money multiplier | 货币乘数 | huò bì chéng shù |
How banks create money
- Banks do not keep all your deposits locked in the vault.
- They keep a fraction and lend the rest out.
- Those loans become new deposits elsewhere — which are lent again.
- So the banking system actually creates money.
Fractional reserve banking
- Under fractional reserve banking 部分准备金银行制度, a bank keeps only a fraction as required reserves 法定准备金 and lends the rest.
- The fraction kept is the reserve ratio 准备金率.
- A new deposit 存款 of reserves ripples outward: lent, redeposited, lent again — a shrinking chain.
Reserves or loans?
A bank keeps a fraction of each deposit as required reserves and lends out the rest, which becomes new deposits — creating money.
The fraction of deposits a bank must keep rather than lend is the ______ ratio.
The reserve ratio sets how much banks keep; the rest is lent out.
The money multiplier
- The most the money supply can grow from new reserves is the money multiplier 货币乘数.
- $\text{money multiplier} = \dfrac{1}{\text{reserve ratio}}$.
- Worked idea. A 10% reserve ratio gives a multiplier of $1/0.10 = 10$.
- So 1,000 of new reserves can grow the money supply by at most $1{,}000 \times 10 = 10{,}000$.
The money multiplier equals:
Money multiplier = 1 ÷ reserve ratio.
The reserve ratio is 10% (0.10). What is the money multiplier?
Money multiplier = 1 ÷ 0.10 = 10.
With a money multiplier of 10, what is the most the money supply can grow from 1,000 of new reserves?
Maximum growth = 1,000 × 10 = 10,000.
It is a maximum
- The multiplier gives the most money can grow, not the exact amount.
- In reality it grows less, because people hold some cash and banks may keep extra reserves.
- A smaller reserve ratio means a bigger multiplier — banks lend more of each deposit.
The money multiplier gives the maximum growth in the money supply, not the exact amount.
People hold some cash and banks may keep extra reserves, so growth is usually less.
A smaller reserve ratio makes the money multiplier:
A smaller reserve ratio means banks lend more of each deposit, so the multiplier is bigger.
Under fractional reserve banking, banks keep a reserve ratio and lend the rest, so the system creates money. The money multiplier = $\dfrac{1}{\text{reserve ratio}}$ gives the maximum growth in the money supply from new reserves.