Money Creation in the Banking System

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This Demonstration shows how banks create money. Every time money is deposited into the bank, part of the money is kept safe by the government (the required reserves), while the rest of the money becomes loanable funds or excess reserves. When the money in the excess reserves is lent to a new person, that money is put into a new deposit and once again some of it goes to the required reserves and the rest becomes excess reserves, and the cycle continues. The total amount of money in the banking system as a result of the initial deposit is found by an infinite geometric series of the initial deposit and the percentage the excess reserve is in relation to the deposit, so the sum of the series is the initial deposit divided by the required reserve percentage. The graph shows the first 10 iterations of the geometric series, showing how the overall money supply grows with each loan.

Contributed by: Alla Ahmad (February 2014)
Open content licensed under CC BY-NC-SA


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