The Reserve Ratio(in detail) Video Lecture | Economics Class 12 - Commerce

hey how unique on students this is mr.
Clifford welcome to ac/dc econ right now
we're gonna talk about how banks create
money out of thin air you heard me right
banks create money out of thin air to
explain how this is possible let's talk
about what a bank does a bank accepts
deposits from his customers but doesn't
just hold that money if all banks did
was hold other people's money there
would be no profit in that
instead what a bank does it takes that
money and it loans most of it out now
why can't it loan all of it out well
because sometimes customers come back
and they want to withdraw some of that
money so if you and I and everybody else
goes the bank the same time to get our
money out the bank does not have that
money they wouldn't be able to pay us
and the bank would default now that's
called a bank run and it's bad really
bad now the United States we have
Deposit Insurance make sure bank runs
like that don't happen but the point is
the bank doesn't hold all those deposits
they loan it out now the amount of
deposits that the bank needs to hold by
law is called a required reserve in the
United States it's 10% this means that
the other 90% is something called excess
reserves and they're free to loan that
out it'll make a whole lot more sense
with an example let's say someone goes
into a bank and the pots a hundred
dollars from their pocket into the bank
now this won't change the money supply
because money from your pocket is part
of money supply so is demand deposits
inside banks so so far there's been no
change the money supply but here's where
the magic happens the bank is going to
hold a certain percentage by law let's
say 10% so they're gonna hold $10 that
means going to loan the other 90 out now
the person who deposited $100 has $100
per bank but the person who borrowed the
90 also has now $90 that $90 is money
that was created from thin air but did
not exist until the lawn hurt now that
person's going to spend that $90 and
eventually that $90 can make its way
back into another bank that other bank
is going to take that $90 it's going to
hold 10% and require reserves so nine
dollars can hold it's go long the other
81 out that 81 new dollars is new money
supply it was not created until the loan
occurred now eventually the person who
borrow the money is going to take it and
spend it and that's going to make its
way to a new bank and the same thing is
going to happen again and again and
again and again and again now it turns
out that the
so the positive $100 is actually going
to become $900 of new money created the
way I got this is by looking at
something called the money multiplier
which is one over the reserve ratio so
in this case when the reserve ratio is
10% that meant the money multipliers 1
over point 1 so it's 10 now you might be
asking yourself if the initial amount
deposited was $100 and the multiplier is
10 why didn't a thousand dollars of new
money get created the reason why is
because the initial hundred dollars was
actually part of the money supply to
start off with so the only amount of new
money that was created was from the
initial loan of $90 and so $90 times 10
is $900 of new money created from the
initial mo is the whole idea of
fractional reserve banking banks hold a
portion of deposits and they loan the
rest out and whenever they loan it out
they create new money did you get that
here let me ask you a question to see if
you actually fully understand that
concept
let's assume instead that the reserve
requirement is 20% and someone deposits
$500 into their bank from their pocket
in the bank $500 assuming that banks
loan out all of their excess reserves
and there's no other leakages how much
would be the increase in the money
supply well the money multiplier is 1
over point 2 it's multiplier is 5 fat
bank is going to hold $100 in required
reserves and their excess reserves of
$400 they're going to loan out that $400
is all new money and all the other steps
cause new money and so it's 400 times 5
which is $2,000 now don't confuse this
idea of skipping that first round with
the same idea of the Fed buying bonds
for example if the Fed bought $500 worth
of bonds so the Fed buys bonds and puts
$500 in the system that whole $500 is
new money so in that situation the new
money created would be 500 times 5 which
would be 2500 now this is tricky but
it's just like the spending multiplier
that you learned back we learn fiscal
policy make sure take a look at my other
videos and my review apps for the ap
economics test until next time