Answer to Question #192347 in Macroeconomics for Warjik Acopian

Question

Please consider the following assumptions for the fractional banking system:

• Banks hold 10% reserves against checking deposits;
• Individuals and corporations divide their monetary assets as 20% cash and 80% deposit; and
• Banks loan their excess reserves to earn profits.

Considering these assumptions, how does $1,000 deposit into an economy multiply? (Money Multiplier Effect) Please explain step-by-step changes in the money supply?

2)How does the money get depleted how much does the bank keep holding back every time?

3)What is the money multiplier it should be from the range of 2.5 to 4. It should not be more.

Answer 1

1) As it is assume that the bank holds 10% of Reserve again checking deposit. If the initial deposit is $1000. Out of which 20% that is equal to $200 heart hold in cash and 80% that is 800 dollars is deposited.

2) Steps involved in money multiplication in the economy.

Since the bank has received deposit of 80 $800 it will have to to keep 10% of this deposit that is $80 in the Reserve and can lend the remaining amount of $720 as loan. But the bank does not give loan of this amount in the hands of the person but open a bank account in his name and depositing this amount in that account . This is all bank create another deposit of $720. After keeping a reserve of 10% that is $72 it will give the remaining amount as loan to another party. This process will carry on until the amount is completely exhausted. The bank will be able to multiply money through this process. Amount of money created through this would depend upon the value of the money multiplier.

3) Value of money multiplier is calculated as follows

Money multiplier =$\frac{1}{reserve\space \%}$

So in the case of above example the value of multiplier would be

=$\frac{1}{10\%}$

=10 times.

The money deposited in bank that is $800 would be become 10 times. With the help of these $800 a bank will able to create $8,000.