Kenneth R. Szulczyk
Your Bank
Assets Liabilities
Required Reserves $1,000
Excess Reserves 9,000
Deposits $10,000Money supply immediately expands by $10,000. Bank must hold 10% of its deposits as
required reserves. Thus, the bank holds $1,000 of reserves against your account as a deposit at
the Fed or as vault cash. However, the bank has $9,000 in excess reserves. These reserves earn
no interest, and consequently, the bank loans them out. For instance, your bank grants a $9,000
car loan to your friend. We display the transaction below:
Your Bank
Assets Liabilities
Required Reserves $1,000
Excess Reserves 0
Loans 9,000
Deposits $10,000Bank sends your friend a check for $9,000. Your friend takes this check to a car dealership
and buys a car. Car dealer deposits this check at his bank, and we record this transaction below:
The Car Dealer’s Bank
Assets Liabilities
Required Reserves $900
Excess Reserves 8,100
Loans 0
Deposits $9,000Did you notice the change in the money supply? Money supply expanded by $19,000
because you have $10,000 sitting in your account, and the car dealership has $9,000 in his
account. Car dealer’s bank must hold 10% of the deposit, equaling $900. Remaining funds,
$8,100, earn no interest. Consequently, the car dealer’s bank lends this out. Car dealer’s bank
grants $8,100 business loan. We record this transaction below:
The Car Dealer’s Bank
Assets Liabilities
Required Reserves $900
Excess Reserves 0
Loans 8,100
Deposits $9,000