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    How is money created?

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    Suppose Bank A, which faces a reserve requirement of 10 percent, receives a $1000 deposit from a customer.

    a. Assuming that it wishes to hold no excess reserves, determine how much the bank should lend. Show your answer on Bank A's balance sheet.

    b. Assuming that the loan shown in Bank A's balance sheet is redeposited in Bank B, show the changes in Bank B's balance sheet if it lends out the maximum possible.

    c. Repeat this process for three additional banks: C, D, and E.

    d. Using the simple money multiplier, calculate the total change in the money supply resulting from the $1000 initial deposit.

    e. Assume Banks A, B, C, D, and E each wish to hold 5 percent excess reserves. How would holding this level of excess reserves affect the total change in the money supply?

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    Solution Summary

    The solution illustrates the process of creation of money. It is included in an attached Word and Excel file.