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Lecture 26:
Multiple deposit
creation
Mishkin Ch 13 – part B
page 341-349
1
Review
Monetary base (MB) = currency in
circulation (C) + reserves (R)
 Open market operations

market purchase  increase MB
 Open market sale  decrease MB
 Open
Discount loans
 Fed has more control over MB than over
reserves

2
Introduction



money supply = monetary base * money
multiplier. How can high-powered money be
multiplied?
How deposits are created? A simple model of
multiple deposit creation.
When the Fed supplies the banking system with
$1 of additional reserves, deposits increase by a
multiple of this amount, this is called multiple
deposit creation.
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Deposit creation: single bank

First National Bank
Assets
Liabilities
Securities
-$100
Reserves
+$100

First National Bank
Assets
Securities
Liabilities
-$100 Checkable
deposits
Reserves
+$100
Loans
+$100
+$100

First national bank
gained $100 additional
reserves from selling
bonds to the Fed.
make $100 loans to a
borrower who deposit
this $100 in checking
account.
The bank creates
deposits by lending:
money supply.
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Deposit creation: single bank –
cont’d
First National Bank
Assets


Liabilities
Securities
-$100
Loans
+$100
The borrower may use the $100 to purchase goods
and services.
When the borrower uses $100 by writing checks,
the $100 reserves leaves First National bank.
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Summary of single bank case
Excess reserves increase
Bank loans out the excess reserves
Creates a checking account
Borrower makes purchases
The money supply increases
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Deposit creation: the banking
system
Bank A
Assets
Reserves

Liabilities
+$100 Checkable
deposits
+$100
Bank A
Assets

Liabilities
Reserves
+$10 Checkable
deposits
Loans
+$90
+$100
Suppose the $100 of
deposit created by
First national bank’s
loan is deposited at
bank A which keeps
no excess reserves.
If the required
reserve ratio is 10%,
Bank A can make
$90 loan.
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Deposit creation: the banking
system – cont’d
Bank B
Assets
Reserves

Liabilities
+$90 Checkable
deposits
+$90
Bank B
Assets
Reserves
Loans
Liabilities
+$9 Checkable
deposits
+$90

+$81

If the borrower
deposit the $90 to
another bank B, then
checkable deposits
in the banking
system increase by
another $90.
But bank B can again
make new loans of
$81.
Bank C …
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Summary of multiple banks case
If all banks make loans for the full amount
of their excess reserves, initial $100
increase in reserves will result in $1000 in
deposit.
 The increase is tenfold, the reciprocal of
10%, the reserve requirement.
 If banks use excess reserves to purchase
securities, the effect is the same as
making loans.

10
Formula for multiple deposit
creation
Assuming banks do not hold excess reserves
Required Reserves (RR) = Total Reserves (R)
RR = Required Reserve Ratio (r ) times the total checkable deposits (D)
r  D=R
Dividing both sides by r
1
 R
r
Taking the change in both sides yields
D=
D =
1
 R
r
The simple deposit multiplier:
1
r
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A comparison


When we have only one bank, it can create
deposits equal only to the amount of its excess
reserves.
However, in a system of multiple banks, there is
a multiple expansion of deposits, because when
a bank loses its excess reserves, these reserve
do not leave the banking system but are used to
make additional loans and create additional
deposits.
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Why this is useful?

If the Fed can set the level of reserves (R) and
the required reserve ratio (r), then can Fed
control the level of checkable deposit (D)?
1
D =
 R
r
1
D =
 R
r
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Critique of the simple model
Banks may not use all of their excess
reserves to buy securities or make loans
 Holding cash stops the process

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