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The Money Multiplier

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When you deposit money into a bank, do you know what happens to it? It doesn’t simply sit there. Banks are actually allowed to loan out up to 90% of their deposits. For every $10 that you deposit, only $1 is required to stay put. This practice is known as fractional reserve banking. Now, it’s fairly rare for a bank to only have 10% in reserves, and the number fluctuates. Since checkable deposits are part of the U.S. money supplies, fractional reserve banking, as you might have guessed, can have a big impact on these supplies. This is where the money multiplier comes into play. The money multiplier itself is straightforward: it equals 1 divided by the reserve ratio. If reserves are at 10%, the minimum amount required by the Fed, then the money multiplier is 10. So if a bank has $1 million in checkable deposits, it has $10 million to work with for stuff like loans and reserves. Now, typically, the money multiplier is more like 3, because banks can always hold more in reserves than the minimum 10%. When the money multiplier is higher, like during a boom, this gives the Fed more leverage to move M1 and M2 with a small change in reserves. But when the multiplier is lower, such as during a recession, the Fed has less leverage and must push harder to wield its indirect influence over M1 and M2. Next up, we’ll take a closer look at how the Fed controls the money supply and how that has changed since the Great Recession. Subscribe for new videos every Tuesday! http://bit.ly/1Rib5V8 Macroeconomics Course: http://bit.ly/2eHWWtC Ask a question about the video: http://bit.ly/2utp1IH Next video: http://bit.ly/2udpA7U
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Text Comments (89)
side husler (1 month ago)
ok, I got it. the whole economy is a scam.
Vyacheslav Lenskyy (2 months ago)
I don't get it. What is the purpose to get credit money and keep it in the checking account? When I need money I usually spend them.
DynamicWorlds (8 days ago)
Poor explanation choice, yes, but when you spend it, it tends to go into someone else's bank account, so the result is the same. Technically he's not wrong, as first it gets put into your account, and then gets transferred to another account (which, as explained, doesn't change the big picture). Remove the names and the result is the same.
Fergal Downes (4 months ago)
Heya buddy, extremely good stream that you have here. Nice one.
Thank you! -Roman
Brett Marshall (5 months ago)
Wow, this is extremely asinine. Banks don't lend out deposits, banks create loans and then wait for deposits.
MsJim70 (4 months ago)
Brett Marshall. True Banks expand the money supply when they grant a loan to a customer ex-nihilo. In the case of the USA and EU Euro zone, but not in the case of the UK there is a reserve requirement associated with the aggregate sums of the sight deposit accounts associated with the said bank group. Sight Deposits are a result of loans granted and transfers from other banks and physical deposits of cash If in retrospect the reserve requirement is not satisfied the bank will need to obtain extra reserves. These may come as a result not just from customer deposits of physical cash or wire transfers from other banks, but from borrowing on the financial markets (other banks) or from the central Bank. Joe Nolan. Customer deposits are a liability of the Bank. An entity cannot lend a liability, only an asset.
Brett Marshall (4 months ago)
+Joe Nolan Check out the websites of the Bank of England & the St Louis Fed. Both clearly explain that the money multiplier is a myth. Banks create money whenever they write loans. They're required to have a percentage of the money they lend out in reserves (deposits at the central bank + vault cash)
Joe Nolan (4 months ago)
Brett Marshall Completely incorrect. Of course they lend out deposits. That doesn’t even make sense. Loans don’t exist without deposits.
Bhrizzy Love (6 months ago)
great visuals!!!!
Quancept (6 months ago)
Great explanation Prof. Alex!
Hasina Baefire (6 months ago)
I need to open a bank ASAP
musicbox193 (7 months ago)
So a loan counts as a deposit but not a transfer?
Raktim Kanti Bhowmick (7 months ago)
Mind-blowing 👌
Amir Sayed (7 months ago)
So in the end it all comes down to a clown called Uncle Sam.
Siddharth Kumar (5 months ago)
Amir Sayed banking works the same in every country
A7med (7 months ago)
The Arabic language......
Nyamaa Bayarma (8 months ago)
Why loans would necessarily increase deposits? What if the person who gets loan doesn't deposit it because he actually spends it?
Siddharth Kumar (5 months ago)
Then someone else will deposit it. The thing is if you spend the money, someone else owns the money now and he won't keep the money in his underwears
Hasina Baefire (6 months ago)
Frost qwerty I don't know why people find things they don't know a thing about funny. hypocrisy is the word, I guess Anyways, people care because that's what makes the system better. If you want no one to think your plans are bs, you'd create a dictatorship. And let me remind you, people overthrew monarchies cause it was bs And I am developing my own economic model just like everyone in our group; leveraging technology and social psychology to make smaller communities and diversified commerce. We'll publish it and wait for old, crappy people to leave office. Then we present it, discuss, if they're stubborn, well.. that's an insiders secret
Frost qwerty (6 months ago)
It is always quite funny listening to people who say Capitalism is bs. well, maybe it is or maybe not. but the point is if you can not offer a better thing, why do you even care about it? as a "fanboy" of economics, I will be glad to hear a better idea from you. Maybe you will even be rewarded for Nobel prize, who knows...
Hasina Baefire (6 months ago)
Consider this, most people deposit cash in their banks sooner or later. First, when you apply for a loan, this loan is credited to your account. You'll have to withdraw it to spend it in the first place Second, whoever who give your loan cash to, they'll be depositing it again in their bank. So in fact spread your money to end up in banks and create more bank credit. This is primary, secondary credit concept but basically all cash ends up creating new bank credit ( new money ) everytime it is taken from ATM, spent outside and redeposited and lent to another person This is good for economy cause businesses have better access to money ( cause its created out of thin air ) but this is extremely disastrous for people who do jobs cause their standard incomes are deflated, more money flowing around means the money you hold will lose its value eventually Imagine it this way, if I had 10 biscuits for my work and the overall number of biscuits in my entire city was 100 I have 10% of total number of biscuits. Now if new biscuits are made, say 200, so total number of biscuits now is 200+100, 300, I'll need 30 biscuits to hold 10% of the total amount. But if I get 10 biscuits and I eat 9 biscuits saving 1 biscuit everytime, I get fewer and fewer % of the total amount even though I'm working just as hard as I did before. This has a real problem with money, cause cost of things is proportional to total amount of money, so more money = stuff costs more, so standard jobs will get deflated, give you less purchasing power over time. And this is where cost of living comes in, it means affordability and ideally public should be able to spend for their needs and save a fraction of that amount with their standard incomes. However, in if you want economy to grow, you need to inflate economy for businesses which actually becomes hell of a problem considering exploitation including low paying jobs that companies offer. This system isn't fair to everyone and needs to be taken down ASAP but the only problem is capitalist fanboys who think they can rule the world but sooner or later hit the rock. This is kinda retarded even when you have a degree in commerce but most humans never developed from apes I guess, so they become capitalists instead
Frost qwerty (7 months ago)
hello there. actually the model which shown in this video is wrong, it has nothing to do with how banks really create money. this model is just taken from economics textbooks(which is wrong). and talking about saving and spending as you ask- you know that when you buy smth in shops or etc by using your bank card, the money which u spend goes to sellers bank account(the same as if he deposited his earned money). and even if u buy by cash, at the end that money will most probably end up in some bank. so just think about it this way. but anyway, the video is completely wrong. good economists are not always good bankers... even professor of Harvard-G. Mankiv, whose economics books are you in most of the countries and universities.
maxi12233 (8 months ago)
The full formula for the money multiplier is 1/(reserve ratio) x 100 otherwise 1/10 would be 0.1 and that is NOT the multiplier as stated in your video - would be great if you made this clear other people might find it confusing
Siddharth Kumar (5 months ago)
maxi12233 actually the same... 10% = 0.1 so 1/ 0.1 = 10
Hamayoon Shah (9 months ago)
Great Teacher
Kiril Mihaylov (9 months ago)
this guy is very good at explaining something 95 % of world population doesn't have a clue about ....after watching the video they still can't get it .....
Ravi Bhatia (10 months ago)
This one is a fantastic explanation, strange that had to wait so long for a credible and meaningful video on a relatively common topic.
Mehad Khattak (1 year ago)
Amazing way of teaching ....
Peter Silva (1 year ago)
I invite you to visit my blog Big Pictures of International Trade at https://bigintertrade.blogspot.ca/ @PeterrS71
Alpha Lobster (1 year ago)
As if a bank would hold more than the minimum...especially in the current environment. In fact, I bet most banks consider the minimum reserve requirement as a target.
Kiril Mihaylov (9 months ago)
so what ?!!? the multiplier still applies .... that's how the system operates .... around the globe ! It is up to banks to decide what amount of money they will loan out .... every banks decides for itself .... learn sdometing about finance for crise sake ....
Ishan Kashyap (1 year ago)
The NCERT book says it's (CDR+1)/(RDR+CDR) where CDR is cash:deposits , RDR is reserve:deposits
Siddharth Kumar (5 months ago)
Ishan Kashyap ncert sucks
Noor Taiyeba (1 year ago)
do people borrow the money to deposit it in the bank again?
Jacobina Ikaku (3 months ago)
what they mean is when someone deposits money in his or her account someone will come borrow it. Its not necessarily one person.
Siddharth Kumar (5 months ago)
You borrow the money and buy a car from me, then I deposit the money. My money is used to give loan to Sam, who uses the loan money to buy a laptop from Rajesh, who deposits the money in the bank. Rajesh's money is used to give loan to Lee, who uses the money to buy a machine from Ali, who deposits the money, which is used to give loan to Jacob, and he ........ I hope you understand the game now
Lewis Rashe (6 months ago)
Noor Taiyeba Yes.
Saurav Kumar (1 year ago)
MsJim70 (11 months ago)
Oh No!. Not the money multiplier myth again. If you really want to understand how modern banks work and prepared to make the effort then I suggest the following :- The Bank of England - They should know as they run the show in the UK. As part of their Quarterly Bulletin for Q1 2014 they published :- "Money creation in the modern economy" ref https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf The Federal Bank of Chicago - Published back in the 60's and unfortunately no longer available from their web site entitled : "Modern Money Mechanics" A Workbook on Bank Reserves and Deposit Expansion available from http://www.rayservers.com/images/ModernMoneyMechanics.pdf The UK based campaign group positive money have a good series of video's explaining things although not always perfectly. http://positivemoney.org/how-money-works/banking-101-video-course/ Also worth a read from the BOE :- https://bankunderground.co.uk/2015/06/30/banks-are-not-intermediaries-of-loanable-funds-and-why-this-matters/ and from CNBC an article Entitled "Basics of Banking: Loans Create a Lot More Then Deposits" https://www.cnbc.com/id/100497710 Happy reading and eventually you may see the light, its not complicated at all when you realise how it works in real world terms and it all makes Logical sense.
MsJim70 (9 months ago)
When customer takes out a loan from a Bank, the customer will be required to sign the loan document specifying repayment of the principal at some future date plus interest. This loan document is legally enforceable and is deemed to have value equivalent to the principal and as a financial instrument can be sold to a third party if required. The Bank retains the Loan document and records the loan as an asset on its books and in return increments the balance in the customers account by the value of the loan merely by typing it in. The balance of customers account is a liability of the Bank. The Banks balance sheet has expanded by the equal increase in assets and liabilities, but the value of the Bank (Shareholder Equity = Assets - liabilities) doesn't change. At this point the "Money Supply" has increased by the principal amount created by the Bank ex nihilo (This is new money, nothing has been taken from anywhere else). The loan principal in the customers account results in a new reserve requirement and the Loan itself results in a new capital requirement. Basel, Tier One and Tier Two and all that. Note When the Loan is re-payed the Money Supply shrinks by the principal amount reversing the banks ex nihilo creation of it. The Bank doesn't get to keep the repaid principal. From my original post the CNBC article Entitled "Basics of Banking: Loans Create a Lot More Then Deposits" contains a an example of an imaginary bank (Scratch Bank) starting from nothing (no assets, no reserves - would never happen in practice of course) and how it could create a loan by charging an arrangement fee, no deposit necessary. https://www.cnbc.com/id/100497710 PS Banks don't act as an intermediary passing on customer deposits as loans to customers and neither do they lend out reserves, excess or otherwise to their customers. Banks do however lend excess reserves to other Banks.
Kiril Mihaylov (9 months ago)
yes , the banks might not decide to loan more money or they might do . ...but that doesn't mean that the explanation is not right .....the money multiplier is real ....
Kiril Mihaylov (9 months ago)
the explanation might not be perfect but still applies ! don't watch positive money - they haven't got a clue about how the financial system works .....
MsJim70 (9 months ago)
True, with a 10% reserve requirement a Bank can support 10 x (reserves) of sight deposit liabliities to its customers. Its the explanation that goes with it that is in my view flawed. See 3.54 mins in Money Multiplier. BOE Money creation in the modern economy - Quarterly Bulletin article https://www.youtube.com/watch?v=CvRAqR2pAgw
Kiril Mihaylov (9 months ago)
what myth are you talking about ?!!? of course there is a multiplier ! that's exactly how the system works ....when you deposit money in a bank it has the legal right to multiply the money by at least 10 % .....sometimes even more ....if Minimal reserve requirement set by the CB is less than 10 % it means the banks can lend even more money making the multiplyer higher... that's exactly how the system works but 95 % of worlds population don't understand anything about banks and financial systems ! even after watching the video they still can't figure it out ! the professsor is absolutely right .....
Dwain Dibley (1 year ago)
There is no such thing as the "money multiplier", it's a moronic fiction that has been debunked countless times. When you deposit cash money into a bank, it does indeed stay in the bank as reserves, and only leaves the bank as withdrawals. Banks do not loan out their reserves, they do not loan money, period. Banks generate credit as deposits and call that a 'loan'. http://carl-random-thoughts.blogspot.com/
Ruy Brb0sa (8 months ago)
this comment is not an angry ideological rambling at all , a blog post is much more credible than virtually every credible macroecon text book ever, everything is a neoclassical conspiracy ,9/11 was a part time job , trust this guy hes woke
賴弘杰 (1 year ago)
Whoever put Chinese subtitles on this video, appreciate that dude.
se7ensnakes (1 year ago)
Bank no longer create money in this manner. This is outdated information. What banks do is to have the customers seeking loans sign promissory notes. The bank take these promissory notes and deposit them in a transaction account. The bank then converts this promissory note into endogenous money which is then used to create a check, or exchange for cash. THE MONEY DID NOT COME FROM ANY EXISTING DEPOSIT. It was created based on a signature. Once the promissory note is paid off the promissory note is void, and the money supply shrink accordingly. The proof of what i am saying is in the empirical data in 2007. Bank reserves were in the tens of billions and consequently if you follow this model it should be in the hundred billion (about 200 billion if you follow this video). But instead we have credit upwards of 7 trillion. BANKS DO NOT LEND FROM DEPOSITS, THEY CREATE THEIR OWN MONEY BASED ON A DEBTORS SIGNATURE.
VessG89 (1 day ago)
@se7ensnakes - incorrect. Fractional reserve baking is very much alive and well.
Kiril Mihaylov (9 months ago)
this is not true ...they do lend money from deposits ! that how commercial banks operate ....
macsnafu (1 year ago)
So? There is still an effective money multiplier effect. What's the ratio of loans to deposits? And what do the banking regulations say?
StatelessLiberty (1 year ago)
I've been listening to a guy called Steve Keen and he makes the following criticism of the money multiplier (in my own words) and I hope Mr. Tabarrok or Mr. Cowen can explain where he's wrong. If a person wants a loan of $X, what's to stop the bank from just marking up their account by $X and looking for reserves later? After all, this does not change the equity of the bank so no foul play. To see how this works, imagine someone were to come to me and ask for a loan for $100. I could just write them an IOU for $100, and they could use that IOU to buy what they need. Reserves are only useful as a guarantee on the value of the IOU—if someone wants to come in and cash in the IOU, I need some cash in reserve. But once a reputation has been established for redeeming IOUs for real cash, people treat the IOU like it's real money and there's little need to cash in the IOU. (For a bank the IOU is the money that appears in your current/chequeing account. And a bank run is what happens when people lose confidence in the redeemability of the IOUs.) In principle, if people did all transactions in terms of the IOUs and nobody ever wanted to redeem the IOUs, the bank could operate without any reserves at all*. And the bank is free to print as many IOUs as it wants, constrained only by profit maximisation. In this way, banks do not need to look for reserves when someone asks for a loan. So the recursive series of transactions, each subject to a fixed "reserve ratio," doesn't seem to occur. You could always argue it's "as if" these transactions occur, and define the reserve ratio as Base money/Total money, but that turns the money multiplier into a tautology without any empirical content. When you view banking this way, it's totally predictable that the massive increase in reserves by the Fed didn't lead to hyperinflation. After all, reserves only exist to convince the public of the redeemability of the banks IOUs, to facilitate the occasional withdrawal, and to facilitate transactions between accounts belonging to different banks (see below). Once these functions have been fulfilled, more reserves doesn't lead to more loans. *This is not quite true since if a person with a Bank A IOU deposits it in Bank B, Bank B will want to redeem this IOU and there will be a transfer of reserves from Bank A to Bank B. Reserves are needed for this situation.
David Glynn (4 months ago)
What are the constraints on the bank? How does the profit maximization work? What is to stop banks lending to everyone?
gtmunch (1 year ago)
Is this related to hypothecation?
Mick Schmick (1 year ago)
So banks are guilty of electronic counterfeiting? If not wouldn't they be guilty of loaning at interest money that does not exist i.e. perpetrating a con job?
Mike Melligan (2 months ago)
What is COUNTERFEIT? In criminal law. To forge; to copy or imitate, without authority or right, and with a view to deceive or defraud, by passing the copy or tiling forged for that which is original or genuine. Most commonly applied to the fraudulent and criminal imitation of money. State v. 11c- Kenzie, 42 Me. 302; U. S. v. Barrett (D. C.) Ill Fed. 309; State v. Calvin, It. M. Charlt (Ga.) 159; Mattison v. State, 3 Mo. 421. https://thelawdictionary.org/counterfeit/ Banks are making legitimate and legal loans through deposits (liabilities) and the excess reserves in their vault (assets).
Gustavo Rivas Méndez (3 months ago)
It would be counterfeiting if they kept that money for themselves. But once the loans are payed back, that created money disappears. They only keep the interest, as payment for their work and to compensate for the clients that defaulted on their loans. The money supply is a breathing entity, that expands and contracts. We learned through many mistakes across time that central manipulation of that flow is very important and necessary.
Emperor Alvis (5 months ago)
You hit the nail on the head. “Fractional Reserve Banking” or a more accurate term, electronic counterfeiting, is nothing more than legalized fraud.
NOVAM AURA (6 months ago)
Mick Schmick basically
mrzack888 (1 year ago)
Bank of England has come out with a paper dispelling fractional reserve. Commercial depository institutes create loans endogenously. The loan become the deposit. Loaning reserves is only bank to bank, and not to customers.
Suso Medin (1 year ago)
mrzack888 And the banks of Germany, Norway.
Straight White Male (1 year ago)
Money multiplier is a neoclassical myth akin to the Loch Ness Monster or Big Foot. There are probably more evidence for the latter, actually.
Emperor Alvis (8 days ago)
DynamicWorlds That’s why gold isn’t currency. It’s money. It shackles money manipulators and severely limits inflation which is stealing value from peoples savings. I agree it’s not perfect, not even close, but it’s far better than what we have. Debt is pretty unavoidable but it can be limited.
DynamicWorlds (8 days ago)
Emperor Alvis  you clearly have not listened to or read the work I mentioned if you think that reply at all relates to what I was saying. Gold and silver coins (or currency redeemable in them) are just as much debt as fiat currency (arguably being fiat in a literal sense themselves) and I'm not saying that currency being debt is a bad thing when properly managed either. Here's a link to the author giving a talk on it. https://youtu.be/CZIINXhGDcs Tl;dr: all real currency is a representation of debts paid to those who work in the public sector and has value because it has universal demand due to being accepted as payment for taxes.
Emperor Alvis (8 days ago)
DynamicWorlds Debt is only a problem when you loan something out at interest.
DynamicWorlds (8 days ago)
+Emperor Alvis gold is not the answer either: all money is debt. Look up "Debt: the First 5000 Years" for more
Emperor Alvis (3 months ago)
Darius Axecaster Exactly. Gold is money, everything else is credit.
Smashinbedrock (1 year ago)
Theiwillsee (1 year ago)
Smashinbedrock drain the swamp
MoNgO OoOoOo (1 year ago)
Smashinbedrock Hell yeah!
insanityzation (1 year ago)
You are completely correct. With interest of reserves, money multiplier theory is even more absurd.
Straight White Male (1 year ago)
The Federal Reserve is not the problem. Money is created endogenously. There is no money multiplier.
Seth Apex (1 year ago)
The Fed has nothing to do with uncle Sam. It's a private bank that has the exclusive right to create money out of thin air. It is accountable to nobody.
macsnafu (1 year ago)
The Fed is accountable to the federal government, as it is the federal government that grants the Federal Reserve certain monopoly privileges and powers, and the federal government could take the privileges and powers away from the Fed, if they wanted to. This is little different from any other government-granted monopoly, except that it has to do with our money supply and interest rates. No private bank on a free market would have the exclusive powers that the Fed has.
Archit Bajaj (1 year ago)
Seth Apex Incorrect
insanityzation (1 year ago)
Wrong. From the Fed's website: "Congress has the power to amend the Federal Reserve Act, which it has done several times over the years." Also, private banks are profit maximizers while the Fed transfers its profits to the Treasury or IOR.
rizu 0606 (1 year ago)
Prof.Alex explains very good
moumita kar (1 year ago)
keep upload new videos
Filippo Generali (1 year ago)
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf , what about this?
Ya boi Neo (10 months ago)
Basically two different ways to explain the same phenomenon. This way is more intuitive but technically wrong.

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