Question

outline the four rounds in the process by which banks create money assuming an initial deposit of $100.00 and a required reserved ratio of 10%

Answer 1

IN THE ABOVE IMAGE,

AS PER THE QUESTION , AN INITIAL DEPOSIT IS MADE INTO THE BANK. AMOUNT DEPOSITED IS $100 , OF WHICH THE BANK IS REQUIRED TO MAINTAIN 10% AS RESERVES AND IS FREE TO LEND OUT REMAINING 90%.. SO , IN ORDER TO MAKE PROFITS (BY CHARGING INTEREST) BANK LENDS OUT 90% OF THE INITIAL DEPOSIT, THAT IS, $90..THIS AMOUNT IS THEN USED BY THE BORROWER TO MAKE SOME PAYMENT AND THE RECEIVER OF THIS PAYMENT THEN DEPOSITS THIS AMOUNT TO THE BANK..SO THE BANK GETS A DEPOSIT OF $90 IN ITS ROUND 2..AGAIN THE BANK IS FREE TO LEND 90% OF THIS DEPOSIT AMOUNT WHICH IS $81 AND REMAINING $9 (10% OF $90) IS IN THE RESERVES OF BANK..SIMILARLY $81 AGAIN IS USED FOR SOME KIND OF PAYMENT BY A BORROWER AND RECEIVER DEPOSITS THIS AMOUNT IN THE BANK...BANK GETS $81 AS A DEPOSIT IN ITS ROUND 3..THE SAME PROCESS IS CONTINUED IN ROUND 3 AND ROUND 4....IN ROUND 3 BANK LENDS OUT 90% OF $81 THAT IS $72.9 AND THIS AMOUNT AGAIN GETS BACK TO THE BANK IN THE FORM OF DEPOSIT...BANK GETS $72.9 AS DEPOSIT IN ITS ROUND 4 AND THE SAME PROCESS CONTINUES THEREAFTER...THIS IS HOW AN INITIAL DEPOSIT OF $100 IS INCREASED TO SOME GREATER AMOUNT IN THE ECONOMY. THIS IS HOW BANKS CREATE MONEY IN THE ECONOMY...THE FINAL AMOUNT GENERATED IN THE ECONOMY IS GIVEN BY THE FORMULA:

MONEY CREATION = (INITIAL DEPOSIT) DIVIDED BY REQUIRED RESERVESV RATIO

SO FOR THIS QUESTION:

MONEY CREATION = $100 / 0.1

= $1000

WHERE, $100 IS INITIAL DEPOSIT AND 0.1 (10%) IS REQUIRED RESERVE RATIO...