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MONEY MILTIPLIERS Defin1tions 1. Money supply : M1 = Currency + Demand Deposits or M=C+DD M=C+DD 2. Total reserves Requiredreserves+Excessreservessetbylawdependonbank 3. Required reserves =R=r = R [1.e. as a proposition of tota1 Deposits] Now, since R=rrDDDD=rr1R DD=rr1R 1= banking systen mult1pl1er. e.8. If FEDsetsrr=107rr1=101=10. Or, In other words, the banking systea can create $10 worth of deposits if Its reserves increase by $1. Queation - What happens if you deposit your $10 bil1 in your pocket at your bank? The bank's deposits increase by $10, but 1ts reserves also 1ncrease by $10.R=$10 of which the bank needs to keep only $1 in the form of reserves [10z of $10] and on lends the rest. Hence, for our purposes, your $10 deposit has increased the banking gystem's reserves by $10 - ve now 80 on to examine the implications of this move for the whole syatea. CASE I a. Bank hold no excess reserves b. You deposic $10 of your cash. c. rr=10Z What happens? a. The bank gets $10 as an increase in reserves 1.e. R=+$10 b. You 100 se $10 worch of currency 1 .e. C=$10 c. Since the whole banking systea holds zero excess reserves. DD=101(+$10)=10$10=$100 d. Money supply change =M=C+DD=$10+$100=+$90 CASE II a. Bank holds $10 in excess reserves b. You withdraw $10 and put it in your p1ggy bank at home c. rr=10z What happens? a. You gain $10 worth of currency 1.e. c=+$10 b. The bank then looses $10 worth of reserves. However, the bank has $10 sitting around as excess reserves which it uses R=$10$10=0 c. Money supply change =M=C+DD=+$100= Withdrawa1] CASE III You withdraw $10 and the bank has $5 as excess reserves; rr=10% Then R - Excess Reserves - Withdrawa1s DD=rT1R=101$5=$50 M=C+DD=+$10$50=$40 HOMEWORK 1. If rr=20% and you deposit $100, what happens to DD, and M. 2. If rr=25% and you withdrau $100, what happens to DD and M if a. the bank has zero excess reserves b. $50 in excess reserves