Here’s an example:
Minimum Reserve Requirement and Monetary Multiplier
Suppose the central bank sets a minimum reserve requirement of 20% for commercial banks. This means that for every 20 in reserve and cannot lend out more than $80.
Let’s say a customer deposits 20 in reserve and can lend out 80 is then deposited into Bank B, which must also hold 20% (64 to another customer. This process continues, with each bank holding 20% in reserve and lending out the remaining amount.
Money Creation
- Initial deposit: $100
- Bank A lends: $80
- Bank B lends: $64
- Bank C lends: $51.20
- …and so on
The total amount of money created is the initial deposit multiplied by the monetary multiplier, which is the reciprocal of the reserve requirement:
Monetary Multiplier = 1 / 0.20 = 5
Total Money Created = 500
In this example, the initial deposit of 500 in new money in the economy.
Note: This is a simplified example and in reality, the process is more complex, but it illustrates the concept of minimum reserve requirement and monetary multiplier.