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Custer County, Nebraska | Don't forget the monetary multiplier. A single commercial bank can only lend an amount equal to its initial pre-loan excess reserves. However a commercial banking system can lend, i.e. create, money by a multiple of its excess reserves.
Depending upon the required reserve ratio, a $100 can create $900 in new money.
Assume the reserve ratio is currently 10%
Example Bank A received $100 deposit. Of this 10% has to be deposited with the Federal Reserve Bank in its district or kept as vault cash. The bank however does now have $90 in excess reserves
A borrower draws a check for $90 -- gives it to someone who deposits it in another bank, Bank B. Bank B now has $90 in new reserves. It also has to take 10% deposit it with the Fed, leaving $81 in excess reserves.
Another borrower draws a check for $81 -- gives it to someone who deposits it in another bank, Bank C. Bank C now has $81 in new reserves. It also has to take 10% deposit it with the Fed, leaving $72.9 in excess reserves.
While we could continue this example, in the end an initial deposit of $100 generates FAR more value than its face value. In this example we generated $243.9.
The Monetary multiplier is calculated by dividing 1 by the required reserve ratio. In our case 1/.10 =10
To determine the maximum amount of new demand-deposit money which can be created by the banking system, we take the excess reserves X monetary multiplier.
So if the commercial banking system has a $15 billion drop in excess reserves, we are talking a drop in demand-deposit expansion by $15 billion X 10 = $150 billion
When storm cloud forms, bankers may cut back on loans, seeking the safety of liquidity (excess reserves)… even if it involves the sacrifice of potential interest income. Bankers fear large scale withdrawals of deposits by the public and doubt the ability of borrowers to repay.
If government throws money at the banking sector, IMHO you will see no increase in willingness to loan money. During the Great Depression, banks had considerable excess reserves but lending was at low levels. When banks cut back on lending, there is a decrease in the money supply; tends to strain aggregate demand and to intensify the recession.
A rapid shrinkage of the money supply contributed to the Great Depression.
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