Unit 4 - Mar 7 (Multiple Deposit Expansion)

Reserve Requirement

• The Fed requires banks to always have some money readily available to meet consumers demand for cash
• The amount set by the Fed is the Required Reserve Ratio
• The Required Reserve Ratio - the percentage of demand deposit (checking account balances) that must not be loaned out
• Typically the Required Reserve Ratio is 10%.

The Money Multiplier

• Shows the impact of a change in demand deposits on loans and eventually the money supply
• Money multiplier = 1/ Required Reserve Ratio
• Example: If the reserve ratio is 25% then the multiplier is 4

The 3 types of Multiple Deposit Expansion

1. Type 1: calculate the initial change in excess reserves (the amount a single bank can loan from the initial deposit).
2. Type 2: calculate the change in loans in the banking system.
3. Type 3: calculate the change in money supply.

• Sometimes type 2 and type 3 will have the same results (I.e. No Fed involvement)

Example 1
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this Federal Reserve purchase of bonds. 
     Amount of new demand deposit - required reserve = the initial change in excess reserve
     $100 million - (20%)($100 million)
     $100 million - $20 million = $80 million in ER

Example 2
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in loans in the banking system from this Federal Reserve purchase of bonds.
     The initial change in excess reserves (the money multiplier)= max change in loans
     $80 million (1/20%)
     $80 million(5) = $400 million max in new loans

Example 3
Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in the money supply from this Federal Reserve purchase of bonds. 
     The maximum change in loans + $ amount of federal reserve action
     $400 million + $100 million = $500 million max change in money supply

A Formula For All Seasons
<{[deposit - (rr% x deposit)] X 1 / rr%} + $ of OMO >
<Maximum change in money supply>
{ max change in loans in banking system}
[initial change in excess reserves]
(Required reserve)

• RR + ER = DD