In the sequel I think I may have gotten just a tad carried away. Read at your peril.
The Wiki article gives a formula for the maximum multiplier. Let’s work through a real example, with sub-maximal multiplication. For this exercize we will not explore whether the bank’s investments are prudent.
[ul]
[li] 1. Adam deposits $1000 at Fop Bank. Fop puts $100 in his vault for the reserve and a sign in the window: “$900! Come and get it!”[/li][li] 2. Bob shows up, agrees to pay interest and walks away with $900. He spends $100 on cocaine, puts $100 under his pillow and gives the rest to Charlie, his plumber.[/li][li] 3. Charlie is wallowing in cash so decides to open a checking account. For simplicity, he chooses Fop Bank.[/li][li] 4. Fop now has $1700 of deposits and $1700 of assets ($800 in cash and Bob’s loan worth $900.) Fop puts another $70 in the vault in case the auditors show up and waits for someone to borrow $630.[/li][li] 5. Donny shows up, but he doesn’t want $630; he wants $2000. “We don’t have that much cash on hand. Take a checking book?” “Sure!”[/li]Fop adds another $200 cash to the reserve in the vault.
[li] 6. Eddie borrows the last $430, buys $30 worth of party paraphanalia and gives the rest to his favorite hooker Felicia.[/li][li] 7. Felicia gives $200 to her coke dealer and deposits the remaining $200 at Fop bank.[/li][li] 8. Fop lends $1800 to George in the form of a cashier’s check. George gives the check to Felicia who deposits it at Fop and takes George for a glorious holiday at Coney Island.[/li][/ul]
At this point, the $1000 of cash (“M0”) is distributed as follows:
[ul]
[li] Bob put $100 under his pillow[/li][li] Party store has $30 of cash from its sale to Eddie[/li][li] The cocaine dealer has sent $300 to the Juarez cartel.[/li][li] The remaining $570 is sitting in Fop’s vault, just enough to serve as reserve for Fop’s demand deposits which total $5700.[/li][/ul]
Fop’s Books balance, assets and liabilities both equalling $5700
Liabilities:
[ul]
[li] We owe Adam $1000[/li][li] We owe Charlie $700[/li][li] We owe Donnie $2000[/li][li] We owe Felicia $2000[/li][/ul]
Assets
[ul]
[li] Bob owes us $900[/li][li] Donnie owes us $2000[/li][li] George owes us $1800[/li][li] Eddie owes us $430[/li][li] Vault Cash $570[/li][/ul]
(Considering how George spent his $1800, his may turn into a “bad loan.” Since he mentions “fdic” sometimes, this might be related to Mr. Mustang’s point.)
Interestingly, M0, as traditionally measured, has been reduced to only $430 ! This is because the required reserves are NOT included in M0 (nor in M1) whether held in the bank’s vault or deposited with the FRB. However, an MB measure may now be more popular than M0, and MB does include those reserves.
Either way, an initial $1000 (whether M0 or M1) has turned into $6030 of M1. The money has “multiplied” by 6.03.