Example 172

CREATION OF BANK MONEY (DEMAND DEPOSITS)

Suppose the Federal Reserve System pours $1000 of new money into the banking system by buying government securities. What will be the total amount of bank money, or demand deposits, that will be generated ultimately?

Following the fractional reserve system, if we assume that the law requires banks to keep a 20 percent reserve backing for the deposits they create, then by the well-known multiplier process the total amount of demand deposits that will be generated will be equal to $1000[1/(1 - 0.8)] = $5000. Of course, $5000 in demand deposits will not be created overnight. The process takes time, which can be shown schematically in Figure 17.3.

$328

$409

$512

$640

$800

$5000

$4000

$3000

$2000

$1000

Initial 1 2 3 4 5 6 7 Final

$1000 Stages in expansion

Was this article helpful?

0 0
Rules Of The Rich And Wealthy

Rules Of The Rich And Wealthy

Learning About The Rules Of The Rich And Wealthy Can Have Amazing Benefits For Your Life And Success. Discover the hidden rules and beat the rich at their own game. The general population has a love / hate kinship with riches. They resent those who have it, but spend their total lives attempting to get it for themselves. The reason an immense majority of individuals never accumulate a substantial savings is because they don't comprehend the nature of money or how it works.

Get My Free Ebook


Post a comment