Required Reserves and the Money Multiplier

When a bank receives a deposit, it must set aside part of it according to the established reserve requirement. The remaining funds are excess reserves and can be lent out.

In our economy of multiple banks, it is very likely that the proceeds of the loan will end up on deposit at another bank. When that happens, the process repeats itself: The bank sets aside required reserves and can lend out its excess reserves. The result is the money multiplier process.

Use the table that follows to learn more about this process. The table begins with an initial deposit of $1,000 to one bank and assumes a required reserve ratio of 20%. Assume the amount lent by one bank is always deposited in another.

1. Calculate the amount of required reserves, excess reserves, and lending at each step in the process. The first boxes of the table are filled in to get you started. Continue until you have filled in five rows of numbers.
2. Now total each column to see how much of the original deposit has ended up in required reserves and how much lending (and creation of money) has occurred so far.

3. If the process continued until the entire $1,000 was in required reserves, what would the total be for the first column?

4. What would happen if there were no required reserves (that is, the required reserve ratio were zero)?

Amount Deposited	Required Reserves	Excess Reserves	Amounted Loaned
$1000	$200	$800	$800
800

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