Principles of Macroeconomics / Unit 11 MAC 1017 worked example, 60 to 90 seconds
Computing the Maximum Change
The idea
Given a change in reserves and the required ratio, compute the largest possible change in deposits and in the money supply. There are two routes and they must agree. Multiply the whole change in reserves by the multiplier to get the change in deposits, or multiply the excess reserves by the multiplier to get the new money the lending creates.
In practice
Continue the course's system: a 2,000 cash deposit at a 20 percent ratio, so the multiplier is five. Route one: deposits can rise by five times 2,000, which is 10,000. Route two: excess reserves are 1,600, and five times 1,600 is 8,000 of newly created deposits, which added to the original 2,000 gives the same 10,000. Now the money supply itself. The 2,000 in cash left circulation when it went into the vault, so the money supply rises by 10,000 minus 2,000, which is 8,000, matching route two exactly.
Where people slip
Deposits and the money supply do not rise by the same amount here, and that gap is the cash that moved out of circulation and into a vault. Answering with the deposit change when the question asked about the money supply overstates the result by the size of the original deposit.
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