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?
Interest?
The increase in the money supply that occurs when a bank receives a $100 deposit despite not having excess reserves can be attributed to the Fractional Reserve Banking system and the concept of money creation. Under the Fractional Reserve Banking system, banks are required to hold only a fraction of deposits as reserves, while the remaining portion can be lent out or invested.
In this scenario, if the reserve requirement is 20%, it means that the bank is obligated to keep 20% of the $100 deposit ($20) as reserves and can use the remaining $80 to make loans or investments. Consequently, the bank can lend out $80 to borrowers, and that $80 then becomes a deposit for someone else's account at another bank.
When this $80 is deposited into another bank, that bank is also required to keep 20% ($16) as reserves and can lend out the remaining $64. This process can continue, with each subsequent bank holding reserves and lending out a fraction of the previous deposit. Through this multiplier effect, the initial $100 deposit can lead to a greater increase in the money supply.
To calculate the total increase in the money supply, you can use the concept of the money multiplier, which is the reciprocal of the reserve requirement ratio. In this scenario, the reserve requirement is 20%, so the money multiplier would be 1/0.2, which is equal to 5. Therefore, the total increase in the money supply would be $100 multiplied by the money multiplier (5), resulting in a $500 increase in the money supply.
It's important to note that the money creation process also depends on individuals and businesses keeping their deposits in banks rather than withdrawing them in the form of cash. If a significant amount of the funds were withdrawn as cash, it would reduce the potential increase in the money supply. Additionally, the actual impact on the money supply may vary due to factors such as banks' willingness to lend and borrowers' demand for loans.