Banking 3: Fractional Reserve Banking

TL;DR

Money creation and the multiplier effect allow for the expansion of the money supply beyond its initial amount.

Transcript

Let's return to our fairly simple banking example, and see if we can use it to actually understand, or at least get a better idea, of what money is and how it's created. So in the original example, I said, I have this idea. I have all of these farmers who, at the end of the season, they sell all of their apples-- let's say that's the main cash crop... Read More

Key Insights

• 💵 Money creation occurs when banks lend out a portion of the deposits they receive, leading to an expansion of the money supply.
• 🤑 The multiplier effect allows for further lending and increases the money supply beyond its initial amount.
• 😫 Reserves are set aside by banks to meet withdrawal demands and maintain stability in the banking system.

Questions & Answers

Q: How does money creation occur in the banking system?

Money creation occurs when banks lend out a portion of the deposits they receive, which increases the money supply beyond the initial amount.

Q: Why do banks set aside reserves?

Banks set aside reserves to ensure they have enough cash on hand to satisfy withdrawal requests from depositors.

Q: What is the multiplier effect?

The multiplier effect is the phenomenon where each deposit leads to additional lending and further expansion of the money supply.

Q: Is money creation limited to the fractional reserve system?

No, money creation can occur with both paper money and gold, as demonstrated in the example. The fractional reserve system facilitates this process.

Summary & Key Takeaways

• Farmers deposit 1,000 gold pieces in a bank and receive interest, while the bank sets aside 10% as reserves and lends the remainder.

• The borrowed 900 gold pieces are used for a project, paid to workers who deposit their money in the bank, which sets aside 10% again.

• The process continues, with each deposit allowing for further lending, resulting in an expanded money supply.