To understand the total credit created in a banking system, one can use the concept of fractional reserve banking and the money multiplier effect. Here’s how the calculations differ when there is a new deposit and when there is not:
1. When There is a New Deposit:
a) Initial Deposit:
- Let’s assume a new deposit (initial deposit) in the banking system. For example, suppose an individual deposits $1,000 into a bank.
b) Required Reserves:
- Banks are required to keep a fraction of deposits as reserves, known as the reserve requirement. Let's assume the reserve requirement is 10% (0.10).
c) Excess Reserves:
- The amount of money that banks can lend out is calculated as: \[ \text{Excess Reserves} = \text{Initial Deposit} - (\text{Required Reserves} \times \text{Initial Deposit}) \]
- So, in our example: \[ \text{Required Reserves} = 0.10 \times 1,000 = 100 \] \[ \text{Excess Reserves} = 1,000 - 100 = 900 \]
d) Money Multiplier:
- The money multiplier (MM) is calculated as: \[ \text{MM} = \frac{1}{\text{Reserve Requirement}} = \frac{1}{0.10} = 10 \]
e) Total Credit Creation:
- The total credit created in the economy from this initial deposit can be calculated as: \[ \text{Total Credit Created} = \text{Initial Deposit} \times \text{Money Multiplier} \]
- In our example: \[ \text{Total Credit Created} = 1,000 \times 10 = 10,000 \]
2. When There is No New Deposit:
Credit Creation without New Deposits: In scenarios where there is no new deposit (e.g., banks choosing to lend out existing deposits rather than receiving new deposits), the process still follows similar principles of how much of existing deposits can be lent out again and again, allowing for credit creation.
The credit creation from existing deposits would still rely on the reserve requirement and lending practices of the banks, but the initial deposit would just be considered as existing deposits.
a) Existing Deposits:
- Suppose the existing deposits in a bank are $5,000, with the same reserve requirement of 10%.
b) Required Reserves from Existing Deposits:
- Required reserves would be: \[ \text{Required Reserves} = 0.10 \times 5,000 = 500 \]
c) Lending Amount:
- The amount available to lend would be: \[ \text{Excess Reserves} = 5,000 - 500 = 4,500 \]
d) Total Credit Creation from Existing Deposits:
- Similar calculations emerge, s: \[ \text{Total Credit Created} = \text{Existing Deposits} \times \text{Money Multiplier} = 5,000 \times 10 = 50,000 \]
- But remember, this would be the maximum potential credit based on the existing deposits without receiving further new deposits.
Summary:
- With a new deposit, you can calculate the total credit created by applying the money multiplier to the deposit.
- Without a new deposit, you must consider the total existing deposits, then apply the same principles based on reserve requirements and the money multiplier to determine the potential credit that can be created.
In both cases, these calculations assume that banks are willing and able to lend out their excess reserves.