How banks turn a single deposit into ten times the original money supply

Ever wonder where your money goes after you deposit it? Banks do not just hold your cash; they lend out the majority of it. This video explains the mechanics of fractional reserve banking and how the money multiplier determines the total impact on the economy.

Under fractional reserve banking, banks are permitted to loan out up to 90% of their deposits, keeping only 10% in reserve. This practice directly influences the U.S. money supply. The money multiplier, calculated as one divided by the reserve ratio, dictates how much total money can be generated from initial deposits. For instance, with a 10% reserve requirement, a $1 million deposit can theoretically support $10 million in total money.

In practice, the multiplier often sits closer to 3 because banks frequently choose to hold more than the minimum required reserves. This ratio is not static; it shifts during economic cycles. During booms, a higher multiplier gives the Federal Reserve significant leverage to influence M1 and M2 money supplies with minor adjustments. Conversely, during recessions, the multiplier tends to be lower, forcing the Fed to exert more effort to achieve the same indirect control over the money supply.

Source: Fractional Reserve Banking and the Money Multiplier Made Simple