Unit 4, Video 5 Summary

The money creation process is how banks actually make money. Money is created by making loans. For example, if the reserve ratio is 20% and the loan amount is $500 is equal to a maximum creation of $2500 dollars in the money supply. This is figured out by multiplying the loan amount by the money multiplier, which is simply 1 over the Reserve ratio. The 2500 makes sense because it is all of the potential loans that could be made if one person withdraws the 500, places 400 into a bank and another withdraws, so on and so forth. This can only happen if there are no excess reserves in these banks. If the banks keep excess reserves, then the grand total of our $2500 is decreased.