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Unformatted text preview: For example, let's say that an economy has a money supply equal to $1000 and that there is a reserve requirement of 50%. If all $1000 is deposited into a bank, half of this amount must be held as reserves to cover withdrawals and half of this amount can be used to make loans. Say the bank gives out $500 in loans. The money is spent and eventually redeposited in the bank. Now, the bank has $1500 deposited. Only $1000 of this amount is in currency. The other $500 is owed to the bank and exists in a form known as a paper balance. The bank has $1500 in deposits, and since it is required to keep half in reserves, it must keep $750 in currency. This leaves only $250 in currency available for loan seekers. This process continues and real balances are replaced by paper balances until the bank can no longer make loans because all of its currency...
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- Fall '10
- Balance Sheet