Banking and the expansion of the money supply

Learning objectives

Explain how a fractional reserve banking system works: banks hold a fraction of deposits as reserves (required plus excess) and lend out the rest

Construct a bank balance sheet (T-account) and show how a new deposit, a loan or a withdrawal changes reserves, loans, deposits and excess reserves

Calculate the simple money multiplier as 1/reserve ratio and the maximum change in the money supply from a change in reserves under a limited reserves framework

Explain why the actual expansion of the money supply is smaller than the maximum when banks hold excess reserves or the public holds more currency

Distinguish a change in the composition of the money supply (currency deposited into a bank) from a change in its size (a new bank loan or an open market operation)