by CrudeAwakening » Sat 08 Aug 2009, 00:46:57
Like all textbook explanations of the so-called "money multiplier", it is misleading.
Banks (a) don't lend reserves to the public, and (b) don't even need reserves in order to lend.
Bank lending is constrained by its capital, not its reserves, which are solely used to meet statutory reserve requirements and to settle accounts with other banks.
Any bank with sufficient capital can lend to a creditworthy borrower, even with deficient reserves. Banks lend first, and seek reserves (from other banks, or the central bank) later.
Even assuming the money multiplier model to be valid, the example he gives is wrong in that it also implies that the money supply is not increased at the point the loan is granted. Total money supply is $190 at step 2. Reserves are $100, loans $90, deposits $190.
Loans create deposits. The example he gives doesn't demonstrate this. To cap it all off, he shows total reserves decreasing as more loans are made.
"Who knows what the Second Law of Thermodynamics will be like in a hundred years?" - Economist speaking during planning for World Population Conference in early 1970s