This preview shows page 1. Sign up to view the full content.
CHAPTER 27
THE MONETARY SYSTEM
619
How much money is eventually created in this economy? Let’s add it up:
Original deposit
±
$ 100.00
First National lending
±
$
90.00 [
±
.9
²
$100.00]
Second National lending
±
$
81.00 [
±
.9
²
$90.00]
Third National lending
±
$
72.90 [
±
.9
²
$81.00]
••
Total money supply
±
$1,000.00
It turns out that even though this process of money creation can continue forever,
it does not create an infinite amount of money. If you laboriously add the infinite
sequence of numbers in the foregoing example, you find the $100 of reserves gen
erates $1,000 of money. The amount of money the banking system generates with
each dollar of reserves is called the
money multiplier.
In this imaginary economy,
where the $100 of reserves generates $1,000 of money, the money multiplier is 10.
What determines the size of the money multiplier? It turns out that the answer
is simple:
The money multiplier is the reciprocal of the reserve ratio.
If
R
is the reserve
ratio for all banks in the economy, then each dollar of reserves generates 1/
R
dol
lars of money. In our example,
This is the end of the preview. Sign up
to
access the rest of the document.
 Spring '10
 abijian

Click to edit the document details