To comprehend the entire process of cash creation today, let’s produce a hypothetical system of banking institutions. We shall consider three banks in this system: Acme Bank, Bellville Bank, and Clarkston Bank. Assume that every banking institutions have to hold reserves add up to 10% of these deposits that are checkable. The number of reserves banking institutions have to hold is named needed reserves. The book requirement is expressed as being a needed reserve ratio; it specifies the ratio of reserves to checkable deposits a bank must keep. Banking institutions may hold reserves more than the necessary degree; such reserves are known as extra reserves. Extra reserves plus required reserves total that is equal.
Because banking institutions make fairly small interest on their reserves held on deposit using the Federal Reserve, we shall assume they look for to keep no extra reserves. [Read more…]