and deposits it. The bank in turn deposits the new $10,000 in its Federal Reserve Bank, increasing its reserves. Let's see what happens. As we said, the "Bank of Fred" was a monopoly bank of issue. In the real modern world, however, we have many decentralized and competitive banks of issue. That makes the real world a little more complex than Fred's fictional world.
Let's see how an increase in monetary reserves leads to the creation of new money in a banking system like the modern American one. Suppose that the reserve ratio is 1/6. Then Joe Blow returns from Russia, where he has sold his used Hewlett Packard computer for $10,000 in crisp $100 bills. Joe takes the money down to his home-town bank, the First National Bank of Enumclaw, and deposits it. The bank in turn deposits the new $10,000 in its Federal Reserve Bank, increasing its reserves. Let's see what happens.
| First National Bank of Enumclaw | ||
|---|---|---|
| 1 | Deposits | 60000 |
| reserves | 10000 | |
| 2 | new deposit | 10000 |
| total deposits | 70000 | |
| required reserves | 11666.6667 | |
| actual reserves | 20000 | |
| excess | 8333.33333 |
In Table 3, part A, step one is before Joe makes his deposit. Step two is after the deposit is made. The deposit increases the bank's deposits and reserves by the same amount, $10,000. But with a 1/6 reserve ratio, the bank only needs to keep $1,666.67 of reserves against Joe's deposit, and so it has excess reserves. And excess reserves are an opportunity. With excess reserves, the bank can increase its profits by making some loans.
Next step: James Roe applies for a loan of $8,333.33 to buy a used Yugo.
Money Creation
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