1. Money Creation Process Alomar_111_MCP

2. A person opens a checking account at bank (A) with (KD100) in cash. • This rises the liability of the bank by (100) • If the bank keeps the (100) in cash, this rises the assets side of the balance sheet Alomar_111_MCP

3. A L Alomar_111_MCP

4. Since cash is part of bank’s reserves, the (100) becomes reserves now A L Alomar_111_MCP

5. If the required reserve ratio = 10%, then reserves can be divided into: • Required reserves = (10%)(100)=KD10 • Excess reserves = 100-10= KD90 Alomar_111_MCP

6. A L Alomar_111_MCP

7. Since excess reserves earn no interest. Bank (A) may choose to make a loan worth of (90). (why not lend the 100)? • The bank make profits now: • (interest paid on loan) – (interest paid on deposits) Alomar_111_MCP

8. A L RR 10 Checkable D 100 ER 0 Loans 90 Alomar_111_MCP

9. Assume now that your friend who borrowed the (KD90), went to bank (A) and opened a checking account Alomar_111_MCP

10. A L RR 19 Checkable D1 100 ER 81 Checkable D2 90 Loans 90 190 190 Alomar_111_MCP

11. Total deposits = KD190 • Since excess reserves earn no interest, bank (A) will make a loan of the (81) to another person. • Excess reserves = 0 • Total loans = KD171 Alomar_111_MCP

12. A L RR 19 Checkable D1 100 ER 0 Checkable D2 90 Loans 171 190 190 Alomar_111_MCP

13. This process will continue… • We started with (KD100) but total deposits increased by more than the initial (KD100) • This is called “money creation” Alomar_111_MCP

14. Deposit multiplier = 1/rrr = 1/0.10=10 • Thus, the total amount of deposits bank (A) can create = (10)(100) = KD1000 • Total loans = 1000 – 100 = 900 (total deposits – total required reserve) Alomar_111_MCP