Multiple Deposit Expansion

Multiple Deposit Expansion
-Reserve Requirement
        *Fed requires banks to ALWAYS have money readily available to meet consumers' demand for cash
        *The amount set by the Fed is the Required Reserve Ratio
        *Required Reserve Ratio is the percentage of demand deposits (checking account balances) that MUST NOT be loaned out
        *Typically the Required Reserve Ration is 10%

Money Multiplier
-Similar to the spending multiplier, money multiplier shows us impact of a change in demand deposits on loans and eventually the money supply
-To calculate the money multiplier divide 1 by required reserve ratio
        *Money Multiplier = 1/Reserve Ratio
                 -Ex. If the reserve Ratio is 25%, then the multiplier is 4 (1/.25 = 4)

3 Types of Multiple Deposit Expansion Questions
-Type 1: Calculate initial change in excess reserves (ER)
        *aka: the amount that a single bank can loan from the initial deposit
-Type 2: Calculate the change in loans in the banking system
-Type 3: Calculate the change in the money supply
         *Sometimes type 2 and type 3 will have the same result
                  -i.e. no Fed involvement

Examples
-Example 1:
       Given a required reserve ration of 20%, assume the Federal reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this Federal Reserve purchase of bonds.
               *Amount of new demand deposit - required reserve = initial change in excess reserves
               *$100 million - (.2 x $100 million)
               *$100 million - $20 million = $80 million in ER

-Example 2:
       Given a required reserve ratio of 20%, assume the Federal reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in loans in the banking system from this Federal reserve purchase of bonds.
               *The initial change in excess reserves (the money multiplier) = max change in loans
               *$80 million (1/.2)
               *$80 million (5) = $400 million max in new loans

-Example 3:
       Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum total change in the money supply from this Federal Reserve purchase of bonds.
              *The maximum change in loans + $ amount of Federal Reserve action
              * $400 million + $100 million = $500 million max change in money supply

A Formula for All Seasons
<{[Deposit - (rr% x Deposit)] x 1/rr%} + $ of OMO>
<Maximum change in the money supply>
{Max change in loans in banking system}
[Initial change in excess reserves]
(Required Reserves)