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Econ: What are Reserve Requirements, Excess Reserves, and Multiple Expansion of Deposits? 15 Views
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Transcript
- 00:00
And finance Allah shmoop What our reserve requirements excess reserves
- 00:06
and the multiple expansion of deposits in the US The
- 00:12
Fed a k a The Federal Reserve a k a
- 00:14
The central bank keeps a watchful eye on reserve banks
- 00:18
who keep a watchful eye on commercial banks So yes
Full Transcript
- 00:21
there's a whole hierarchy If the Fed is like a
- 00:24
royal family well then reserve banks or dukes and duchesses
- 00:27
and the commercial banks are aristocrats The Fed requires banks
- 00:31
to meet reserve requirements also known as the cash reserve
- 00:36
ratio which is the amount of money banks have to
- 00:38
keep on hand Handy Dandy Ready for quick withdrawal Why
- 00:41
is this a rule Well part of what spawned the
- 00:44
Fed into existence in the first place was a siri's
- 00:47
of runs on banks from banking panics A run on
- 00:50
the bank is when everyone rushes to their bank and
- 00:53
demands all of their deposits back Now the thing is
- 00:57
one of the boys banks make money is by lending
- 00:59
out your money to other people Yep your money Your
- 01:02
deposit for banks to make the most money possible Well
- 01:05
they would lend out as much money as they could
- 01:08
which in theory would be all of it But then
- 01:09
that leaves you the deposit or without cash when you
- 01:13
need it The Fed wanted runs on banks to be
- 01:15
a thing of the past which they pretty much are
- 01:17
now so they made these reserve requirements The money that
- 01:20
banks are allowed to loan out are called the excess
- 01:23
reserve For instance a bank may be required to have
- 01:26
say ten percent of its total money on hand which
- 01:29
would mean the remaining ninety per cent of the money
- 01:31
is excess reserves which banks can lend out to turn
- 01:34
a profit Now here's where the magic happens Multiple expansion
- 01:38
of deposit Well multiple expansion of deposits is the theory
- 01:42
that each deposit into a bank creates additional money made
- 01:45
from excess reserve deposit as they are well continuously lent
- 01:50
out by banks and then re deposited in other banks
- 01:53
There's a literal multiplier effect that ripples outward into the
- 01:56
economy called the Deposit Expansion Multi a buyer which estimates
- 02:01
the maximum amount of money that the Fed could expect
- 02:03
in deposit injection into the economic system that you know
- 02:08
they were kind of creating and managing Well this is
- 02:10
how the Fed the controller of the money supply decides
- 02:13
how much new money toe pump into the economy and
- 02:16
the maximum effect they could possibly expect from that injection
- 02:20
of money into the system For instance let's say your
- 02:23
bank has a ten percent reserve requirement leaving ninety percent
- 02:26
in excess reserves Well when that money is lent out
- 02:29
whether to a consumer or a business it's deposited into
- 02:32
another bank eventually So let's say you deposited two thousand
- 02:37
dollars check into your bank account in your bank says
- 02:39
would be and it lends out ninety percent of it
- 02:41
which is eighteen hundred box right that other two hundred
- 02:43
dollars they were going to keep on hand for reserve
- 02:46
requirements Okay so let's say that eighteen hundred dollars is
- 02:48
linked to a climber Chris who's keen on climbing Mount
- 02:52
Everest climber Chris deposits that eighteen hundred dollars into his
- 02:55
bank account Clymer Chris's bank says would be just like
- 02:59
your bank and they do the same thing that bank
- 03:01
lens Ninety percent of the eighteen hundred dollars which is
- 03:04
sixteen hundred twenty bucks The remaining ten percent that hundred
- 03:07
eighty is kept at Climber Chris's Bank to meet reserve
- 03:10
requirements Well Climate Chris Bank then lends out six hundred
- 03:13
twenty dollars to teacher Tina who's running short on school
- 03:16
supplies and gas Teacher Tina What's that Sixteen twenty into
- 03:20
her bank account And you can guess what teacher Tina's
- 03:23
bank account does Yep same is your bank and same
- 03:25
as Climber Chris's bank and teacher Tina's bank lends out
- 03:28
ninety percent of the money she deposit which is a
- 03:30
fourteen hundred forty eight dollars to Dan the Man and
- 03:33
so on Under this system and initial deposit actually grows
- 03:36
providing more value than the initial amount deposited Its multiplied
- 03:41
each time money is loaned out and then re deposited
- 03:43
only ninety percent That deposit gets turned into a new
- 03:45
loan Well we could keep taking ninety percent of the
- 03:48
deposits The maximum amount thanks can loan out from that
- 03:51
deposit until the amount loaned out deposited gets just any
- 03:55
words No more counting anymore So you still have that
- 03:58
two thousand dollars in your bank account that belongs to
- 04:00
you Meanwhile climate Chris has eighteen hundred and you can
- 04:03
spend a teacher Tina has sixteen twenty that she can
- 04:06
spend and it all came from your initial deposit Thank
- 04:09
you very much Well how Khun to Grand that was
- 04:11
in your bank account multiply into additional value that other
- 04:15
people can use in the economy But we told you
- 04:18
that multiple expansions of deposits was magic It literally expands
- 04:22
the money supply Will remember that deposit expansion multiplier we
- 04:25
mentioned earlier It's how the Fed can measure the maximum
- 04:28
amount of money and initial injection of a deposit like
- 04:31
your two grand can be expected to create Will the
- 04:34
deposit expansion multipliers just calculated as one divided by the
- 04:38
reserve requirements sonar case That's one By the by point
- 04:42
one or ten we can use the deposit expansion multiplier
- 04:45
to see how much money you're too grand Deposit expanded
- 04:47
the money supply under this setting to figure out how
- 04:49
much a deposit expanding the money supply We just multiply
- 04:52
the expansion multiplier by the initial excess reserves On our
- 04:55
scenario the reserve requirements ten percent which gives a deposit
- 04:58
expansion multiplier of ten Then we take that excess reserves
- 05:01
from the initial deposit You know that ninety percent chunk
- 05:03
of money that was created into the first loan for
- 05:06
climate Chris by your bank and I was eighteen hundred
- 05:08
bucks right So you're going to multiply that eighteen hundred
- 05:10
by ten So ninety percent ofyour deposit was loaned out
- 05:13
on deposit to Climate Chris and I sounded out blown
- 05:16
out positive Tina and I pretended I was loaned out
- 05:18
and positive Dan the Man and so on So if
- 05:20
we assume the bank's loaned out ninety percent of stage
- 05:22
while then it means the money supply was expanded by
- 05:25
eighteen thousand dollars That means assuming a reserve requirement of
- 05:29
ten percent for all commercial banks while your initial deposit
- 05:32
of two grand expanded the money supply nine times to
- 05:36
be eighteen thousand dollars in the economy Yes you Khun
- 05:39
tell everyone you're welcome Okay So besides feeling likea money
- 05:43
expansion superhero why do we care about multiple expansion of
- 05:47
deposits Well the Fed is in charge of keeping the
- 05:50
economy healthy One major way of doing that is by
- 05:52
maintaining the money supply you can think about That is
- 05:55
a doctor and the economy is a patient with the
- 05:58
money Supply is well the blood pressure A low blood
- 06:00
pressure like a low money supply means multiple expansion of
- 06:04
deposit is low which means there's less money flowing through
- 06:07
the economy which results in less spending and slower economic
- 06:10
growth Yeah no likey Blood pressure that's too high like
- 06:14
a high money supply isn't good either though we've seen
- 06:16
it before in history where a government just starts printing
- 06:19
more and more money without the corresponding economic growth and
- 06:22
what happens well hyperinflation prices of everything skyrocket and money
- 06:27
becomes almost useless People lose trust in the system And
- 06:30
oh that's so not good for the economy So that
- 06:33
two dollar milk and now it's one hundred dollars a
- 06:35
carton a month later Six thousand Some places have faced
- 06:39
hyperinflation of like three thousand percent a year or more
- 06:42
Well the feds jobs to keep the economy's money supply
- 06:44
like blood pressure stable which means it needs to be
- 06:47
not too high not too low Well when the Fed
- 06:50
raises interest rates it essentially lowers the demand for loans
- 06:54
It lowers the amount of access reserve loaned out and
- 06:56
that whole process slows the growth of the money supply
- 06:59
from slower expansions of deposits When the Fed lowers interest
- 07:03
rates it's trying to increase demand for loans encouraging the
- 07:06
multiple expansion of deposits to grow the money supply well
- 07:09
Besides interest rates the Fed can tinker with things like
- 07:12
stimulus packages and other strategies to expand or contract the
- 07:16
money supply They do all kinds of things They're sort
- 07:19
of crazy All right so now you know money does
- 07:21
not grow on trees but well it does grow out
- 07:23
of your bank account So let's go deposits him though
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