Principles of Economics- Mankiw (5th) 599

Principles of Economics- Mankiw (5th) 599 - CHAPTER 27 T H...

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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,
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