Description                                  
In this presentation, the narrator describes how the banking system creates money.  

Narrator: 
Because the U.S. banking system is a fractional reserve system, individual banks can have excess reserves. Using these excess reserves, the banking system creates money. 

Narrator: 
If the Federal Reserve forced banks to hold 100% required reserves, institutions would be unable to issue loans and the banking system would be unable to create money. 

Narrator: 
To see how the banking system is able to create money, assume initially that there are no excess reserves available to the bank of Pleasantville and that the requirement ratio is 10%. 

Narrator: 
Suppose Marge decides to take $1000 from under the mattress of her bed and deposits this money into her checking account at the bank of Pleasantville. The bank of Pleasantville now has additional reserves of $1000 and it increases the balance of Marge's checking account by $1000. The bank is now required to hold $100 in required reserves and has $900 in excess reserves. Because the bank of Pleasantville now has excess reserves, it is free to create earning assets or loans. 

Narrator: 
Suppose Mort, the farmer, comes to the bank of Pleasantville and asks for a short-term loan of $900 to purchase feed for his ostriches. The bank gives Mort the loan, and issues a check to Mort. Mort immediately deposits this check at the First Farmers Bank, where he has being doing business for twenty years. First Farmers now increases Mort's checking account balance by $900 and also has $900 in reserves. First Farmer's must hold $90 in additional required reserves and can use $810 to write loans. 

Narrator: 
This process continues when Max comes to First Farmers and asks for an $810 loan for a computer purchase. First Farmer's Bank issues Max a check for $810 and he deposits this check in his checking account at Mercantile Bank. Mercantile Bank now increases Max's checking account balance by $810. Mercantile Bank now has an additional $810 in reserves. The bank must hold an additional $81 in required reserves and can use the remaining $729 to write loans. 

Narrator: 
If we examine this process across all three banks, we see that each successive loan as well as the required reserve accounts get smaller and smaller with each successive round.  

Narrator: 
The question is... where will this stop? The process will continue until all excess reserves have been exhausted. 

Narrator: 
If the value of the increases and demand deposits across all banks are summed, we find that demand deposits in the system have increased by $10,000. Since demand deposits are considered to be money, as defined in the Fed's M1 measure, the banking system has created a $10,000 increase in the money supply. So, in the final analysis, we find that the banking system has created $10,000 from Marge's original $1000. 

Narrator: 
If we divide the total increase in demand deposits by the original change in reserves, we find that the total change in demand deposits is ten times that of the original change in reserves. This multiple is known as the money multiplier. Note that the multiplier is also equal to one over the required reserve ratio. 

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