Assume the banking system is in reserve equilibrium. The Fed conducts an open market purchase of Treasury securities in the amount of $1 billion. The reserve requirement against deposits is 10%. Identify the potential amount of the money supply increase as a consequence of the Fed's action and describe fully how money is created by the banking system subsequent to the Fed's open market purchase of Treasury securities in the amount of $1 billion.© BrainMass Inc. brainmass.com October 24, 2018, 10:51 pm ad1c9bdddf
Money multiplier represents the ability of a fractional-reserve banking system to create money within the economy, that is, for each dollar of reserves; the money supply is some multiple of that value.
The Money Multiplier
The money multiplier tells us the maximum amount of new demand-deposit money that can be created by a single initial dollar of excess reserves. This multiplier, m, is the inverse of the reserve requirement, R: m = 1/R. This note will demonstrate that fact.
Suppose some initial amount, d1, is deposited into the banking system. With a reserve requirement of R, this deposit creates initial excess reserves equal to E1 = (1 - R) x d1. Assuming all of this amount is lent out and redeposited within the system, these excess reserves become new money: D M1 = E1 = (1 - R) x d1. This second deposit creates its own excess reserves equal to E2 = (1 - R) x D M1 = (1 - R) x E1. Again, this is redeposited as new money, so that D M2 = (1 - R) x E1. Continuing on like this ...
Money multiplier is summarized.
How does the money multiplier differ when currency holdings are zero, compared to when currency holdings are greater than zero?View Full Posting Details