How Banks Create Money

Key Concepts and Summary

We define the money multiplier as the quantity of money that the banking system can generate from each $1 of bank reserves. The formula for calculating the multiplier is 1/reserve ratio, where the reserve ratio is the fraction of deposits that the bank wishes to hold as reserves. The quantity of money in an economy and the quantity of credit for loans are inextricably intertwined. The network of banks making loans, people making deposits, and banks making more loans creates much of the money in an economy.

Given the macroeconomic dangers of a malfunctioning banking system, Monetary Policy and Bank Regulation will discuss government policies for controlling the money supply and for keeping the banking system safe.