My motivation and mission:
Google sheet that contains list of all WCD lessons and links to all content:
Lesson reviewing how to use Google sheet:
In Lesson 018, I will be explaining fractional reserve banking; this is how banks can “create” money out of thin air. This is a foundational concept to understand in order to understand fiscal/monetary policy, debt, and macro economics.
Topics in Lesson 018
Fractional reserve banking introduction
Monetary base (MB / M0) (central bank money supply)
M1 and M2 money supply (commercial bank money)
How central banks try to simulate the economy
My grandfather received his PHD in economics while studying under Milton Friedman at the University of Chicago - Booth’s School of Business.
My grandfather told me the most important concept that I needed to understand about macro economics is how banks “create” money.
The mechanism by which banks create money is fractional reserve banking.
I recommend watching this Khan Academy Video. It explains how banks can continuously keep loaning out money.
Effectively, in the USA where there is a 10% reserve requirement
Bank 1 - $1,000 deposit >> Can loan out $900 >> Gets deposited in Bank 2
Bank 2 - $900 deposit >> Can loan out $810 >> Gets deposited in Bank 3
Bank 3 - $810 deposit >> Can loan out $729 >> Gets deposited in Bank 4
Bank N - $XXX deposit >> Can loan out 90% * XXX >> Gets deposited in Bank 2
The result of this phenomena is a geometric sequence and additional money getting “generated” from banks loaning out the base money supply that was provided by the central bank.
If you solve this geometric sequence, you end up with the simple formula below:
M1_Max = MB / RR
M1_Max = Commercial Bank Money (maximum theoretical limit)
MB = Base Money (AKA Central Bank Money, or M0)
RR = Reserve Requirement (In the USA this is 10%)
M1_Max is the theoretical money supply that could be created by commercial banks if they lent out the maximum amount of their reserves (they kept only the minimum reserve requirement in the bank and loaned out the rest).
MB = M0 is the monetary base that is printed by the central bank. In the United States this is the federal reserve.
Another way to look at this theoretical limit is that there is a money multiplier between the central bank money supply and the commercial bank money supply.
The commercial bank money supply will be a multiple larger than the central bank money supply which is the inverse of the reserve ratio.
m = 1 / RR = M1_Max / MB
RR = 10% m = 10
RR = 20% m = 5
RR = 50% m = 2
How Central Banks Stimulate the Economy
Print money by buying treasuries. Effectively, they generate dollars out of thin air to purchase treasuries. Treasuries go on the federal reserve’s balance sheet and the dollars get injected into the money supply.
HOLD - Need to expand on this
Some Additional Information on Money Supply
Summary
HOLD
Reference Material & Social Media
In Lesson 030 I cover how to navigate and utilize the Google Sheet I have built for all WCD lessons. This Google Sheet contains a worksheet for each WCD lesson. Each sheet has all of the Excel calculations, tables, graphs, and charts that I have posted in the respective WCD lesson. Additionally, the Google Sheet has a master “Index” worksheet that has links to all of the content associated with each lesson.
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