Credit Creation

Economy Two Sectors Public

$
Bank

Public .

$ Bank .

Assumptions ‡ ‡ ‡ ‡ Fractional reserve banking system Demand deposit only No excess reserves No cash leakage .

Illustration ? ‡ Required reserve ratio (RRR) =25% ‡ Jack put $200 into the bank as an initial demand deposit .

First Round .

First Round $200 Public $ Bank .

First Round $200 Public $ Bank $150 .

Second Round .

Second Round $200 $150 Public $ Bank $150 .

5 $150 .Second Round $200 $150 Public $ Bank $112.

Third Round .

5 Public $ Bank $112.5 $150 .Third Round $200 $150 $112.

5 Public $ Bank $84.Third Round $200 $150 $112.4 $112.5 $150 .

Nth Round .

$84.5 $150 Public $ Bank . . .4 $63.5 $84. .Nth Round $200 $150 $112.4 $112.3 .

.4 $63. $84. .3 .5 $84. .Nth Round $200 $150 $112.5 $150 Public $ Bank .4 $112.

4 5th round : $63. .3 6th round : 7th round : .Credit Creation 1st round : $200 2nd round : $150 3rd round : $112. .5 4th round : $84.

Credit Creation Total ? .

Calculation of Credit Creation 1 Bank multiplier = Required reserve ratio Total deposit increment = initial deposit x banking multiplier $ Bank .

$ Bank .

Remember ? ‡ Required reserve ratio (RRR) =25% ‡ Jack put $200 into the bank as an initial demand deposit .

1 Bank multiplier = Required reserve ratio 1 25% = =4 .

Total deposit increment = initial deposit x banking multiplier Total deposit increment = $200 x 4 = $800 The maximum amount of deposit created is $800 .

$200 RRR=25% Multiplier = 4 Bank $800 .

P. C. Ed (Part time) Major : Economics Designed by Eric Leung 97 .

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