Introduction to Finance

TA B L E 5 . 1
Multiple Expansion of Deposits—20 Percent Reserve Ratio
Assets
Liabilities
Reserves
Loans and 
Investments
Checkable 
Deposits
Total
Required
Excess
Initial
Reserves
$1,000
$ 200
$800
$ 0
$1,000
Stage 1
1,000
360
640
800
1,800
Stage 2
1,000
488
512
1,440
2,440
Stage 3
1,000
590
410
1,952
2,952
Stage 4
1,000
672
328
2,362
3,362
Stage 5
1,000
738
262
2,690
3,690
Stage 6
1,000
790
210
2,952
3,952
Stage 7
1,000
832
168
3,162
4,162
Stage 8
1,000
866
134
3,330
4,330
Stage 9
1,000
893
107
3,464
4,464
Stage 10
1,000
914
86
3,571
4,571
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Final
Stage
$1,000
$1,000
$ 0
$4,000
$5,000

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120
C H A PT E R 5 Policy Makers and the Money Supply
In the examples above, no allowance was made for either cash leakage or currency 
withdrawal from the system. In actual practice, as the volume of business in the economy 
increases, some additional cash is withdrawn for hand-to-hand circulation and to meet the 
needs of business for petty cash.
Money may also be withdrawn from the banking system to meet the demand for payments 
to foreign countries, or foreign banks may withdraw some of the money they are holding on 
deposit in U.S. banks. The U.S. Treasury may withdraw funds it has on deposit in banks. All 
of these factors reduce the multiplying capacity of primary deposits.
Furthermore, this process can go on only if excess reserves are actually being lent by the 
banks. This means that banks must be willing to lend the full amount of their excess reserves 
and that acceptable borrowers who have a demand for loans must be available.
The nonbank public’s decisions to switch funds between checkable deposits and time or 
savings deposits also will infl uence the ability to expand the money supply and credit. This is 
explored later in the chapter.
Contraction of Deposits
When the need for funds by business decreases, deposit expansion can work in reverse. 
Expansion takes place as long as excess reserves exist and the demand for new bank loans 
exceeds the repayment of old loans. Deposit contraction takes place when old loans are being 
repaid faster than new loans are being granted and banks are not immediately investing these 
excess funds.
Assuming that Bank A has no excess reserves, let us see the eff ect of a loan being repaid. 
Before the borrower began to build up deposits to repay the loan, the bank’s books showed 
the following: