March 24, 2017

Money creation formula

• A single bank can create money by the amount of its excess reserves
• The banking system as a whole can create money by a multiple of the excess reserves
• MM X ER = expansion of money
• Money multiplier = 1/RR

New vs existing money

• If the initial deposit in a bank comes from the FED or bank purchase of a bond or other money out of circulation (buried treasure), the deposit immediately increases the money supply
• The deposit then leads to further expansion of the money supply through the money creation process
• Total change in MS if the initial deposit is new $ = deposit + $ created by banking system
• If a deposit in a bank is existing money (already counted in M1; ex - currency or checks), depositing the amount does NOT change the MS immediately because it is already counted
• Existing currency deposit into a checking account changes only the composition of the money supply from coins/paper money to checking account deposits
• The change in the MS if deposit is existing money = banking system created money