Change in Money Supply You go to the bank and deposit $100. If the required reserve ratio is 10%, the bank is required by law to keep $10 (10% * $100 = $100*0.1 = $10) in the bank as required reserves. However, the bank now has $90 in excess reserves . The bank’s goal is to maximize profit so it loans the $90 to a customer. That customer takes the money to the bank and deposits it. That bank is required to keep $9 ($90*10% = $9) as required reserves. But this bank has $81 dollars as extra reserves; the bank loans this out. Whoever gets this $81 deposits it into the bank… If we stop here, we can see a change in money supply. Generally, we can think of money equal to cash + deposits. (This general idea matches up with M1.) With this definition in mind, (M = C + D) the initial money ($100 = M = $100 + 0 to correspond with C + D) has grown. It is now equal to $171 = (-$100) + ($100+$90+81) If we keep doing this, we see that it will look something like: Change in Money Supply = (-$100) + ($100 + $90 + $81 + $72.90 + (1.00 – 0.1)* $72.90 + … = $900
This is the end of the preview. Sign up
access the rest of the document.