Principles of Macroeconomics / Unit 11 MAC 1015 worked example, 60 to 90 seconds
Following a Deposit Through the Banking System
The idea
Trace a cash deposit through successive banks and watch deposits grow. At each step the receiving bank keeps the required fraction and lends the rest, the borrower spends it, and the money lands at another bank, which does the same. Use a required reserve ratio of 20 percent throughout.
In practice
A customer deposits 2,000 in cash at the first bank. That bank must keep 400 and has 1,600 in excess reserves, which it lends. The borrower spends it and the 1,600 is deposited at a second bank, which keeps 320 and lends 1,280. That is spent and deposited at a third bank, which keeps 256 and lends 1,024. The loans form a shrinking chain: 1,600 then 1,280 then 1,024 and onward. Note what each bank can report honestly: the first bank took in 2,000 and ended with 2,000 in deposits, so from its own books it created nothing.
Where people slip
Each bank lends its excess reserves, never the whole of the deposit it received. Lending out the full 2,000 would leave the first bank with reserves below its requirement as soon as the cheque cleared. This is the single most common error in working the chain, and it inflates every later round.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
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