posted by Carter on .
If the reserve requirement is 20% and a bank doesn't have excess reserves, why would a $100 deposit lead to a greater than $100 increase in the money supply.
because of the money multiplier.
A $100 deposit (e.g., into a checking account) gives the bank both a $100 liability and a $100 extra total reserve, AND THEREFORE, an extra $80 excess reserve. What does the bank do with this excess? Lends it out. $80 of money supply just created. This $80 is put into that person's checking account or is immediately spent and goes to the merchant's checking account. Excess reserves at that bank rise by .2*80=$64 And the process repeats until there is no more excess reserves.