Suppose the simplified consolidated balance sheet shown below is for the entire

Question

Suppose the simplified consolidated balance sheet shown below is for the entire commercial banking system. All figures are in billions. The reserve ratio is 10 percent. What is the monetary multiplier? What amount of excess reserves does the commercial banking system have? What is the maximum amount the banking system can lend? Show in column 1 and 2 how the consolidated balance sheet would look after this loan amount has been made. How is money created and destroyed by the commercial banking system in this example?

Explanation / Answer

(a)

Money multiplier = 1 / Reserve Ratio = 1 / 0.1 = 10

(b)

So, required reserve out of total deposits = $100 billion x 10% = $10 billion

Excess reserves = Total reserve - Required reserve = $(26 - 10) = $16 billion

(c)

Maximum amount it can lend is its Excess Reserves of $16 billion (Required reserves are maintained with Central Bank, not allowed for lending).

(d)

After lending out the excess reserves of $16 billion, balance sheet will look like (all values in $billion):

(e)

Total additional money created = Excess reserves x Money multiplier

= $16 billion x 10 = $160 billion

No money is destroyed by credit creation process.

Required Reserves 10 Checkable Deposits 100 Excess Reserves 0 Securities 24 Loans 66

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