Banking: Multiplier Effect and the Money Supply

The banking system as a whole can create an amount of money that is a multiple of deposits. The bank lending leads to new deposits in the banking system and a multiplier effect on the money supply. In a check-able deposits only system (no cash), the money supply equals bank reserves divided by the reserve ratio.

M = 1/ reserve requirement (RR) Currently: M = 1/0.1 = 10 M x bank reserves = money supply

The size of the money multiplier is reduced when funds are held as cash rather than as check-able deposits. The maximum deposit expansion possible (i.e., max growth in money supply) is excess reserves times the money multiplier.

This video how “money” is created in a fractional reserve banking system. It provides M0 and M1 definitions of the money supply.