[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

the $1 billion in currency to the Fed and is credited with the amount, so it now has
$1 billion in reserves. Because its reserves have increased by $1 billion and its deposits
by $10 billion, it has satisfied the 10 percent reserve requirement. The bank also has
$9 billion in loans, so its assets have gone up by $10 billion, the $1 billion in reserves
and the $9 billion in loans.
This relationship between the change in reserves and the final change in deposits
is called the money multiplier. We can reach the same conclusion by a slower route,
as shown in Table 28.5.
Money Multipliers with Many Banks The money multiplier works just as
well when more than one bank is involved. Assume our billionaire deposits
$1 billion in currency with BankNational, which then, after setting aside 10 percent
to meet its reserve requirement, lends $900 million to Desktop Publishing.
Desktop Publishing then orders equipment from ComputerAmerica, which banks
with BankUSA. When Desktop Publishing writes a check for $900 million to
ComputerAmerica, $900 million is transferred from BankNational to BankUSA.
Once that $900 million has been transferred, BankUSA will find that it can lend
more than it could previously. Out of the $900 million increase in deposits, it must
set aside 10 percent, or $90 million, to satisfy the reserve requirement, but it can
then lend out the rest, or 0.9 × $900 = $810 million. Suppose it lends the $810 million
to the NewTelephone Company, which uses the money to buy a machine from
Equipment Manufacturing. If Equipment Manufacturing promptly deposits its payment
into its bank account at BankIllinois, then BankIllinois will find that its deposits
have increased by $810 million; it therefore can lend 0.9 × $810 = $729 million after
meeting the 10 percent reserve requirement. In this example, total deposits have
increased by $1 billion plus $900 million $810 million plus $729 million, or $3.439 billion.
But this is not the end of the process. As each bank receives a deposit, it will
increase its lending. The process will continue until the new equilibrium is identical
to the one described earlier in the superbank example, with a $10 billion increase
in deposits. The banking system as a whole will have expanded the money supply
by a multiple of the initial deposit, equal to 1/(reserve requirement).
In this example, there were no “leakages” outside the banking system. That is,
no one decided to hold currency rather than put the money back into a bank, and
sellers put all that they received into their bank after being paid. With leakages, the
increase in deposits and thus the increase in the money supply will be smaller.
In the real world these leakages are large. After all, currency held by the public
amounts to almost 50 percent of M1. The ratio of M1 to currency plus reserves
held by the banking system is under 3, and even for M2 the ratio is less than 10.
Nevertheless, the increase in bank reserves will lead to an increase in the money
supply by some multiple.
When there are many banks, individual banks may not even be aware of the role
they play in this process of expanding the money supply. All they see is that their
deposits have increased and therefore they are able to make more loans.
The creation of multiple deposits may seem somewhat like a magician’s trick of
pulling rabbits out of a hat; it appears to make something out of nothing. But it is, in
624 ∂ CHAPTER 28 MONEY, THE PRICE LEVEL, AND THE FEDERAL RESERVE