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> If I put a dollar in my savings account and the bank loans it out to someone else, who has the dollar? Note that for every dollar you put into a U.S. bank ac

> If I put a dollar in my savings account and the bank loans it out to someone else, who has the dollar? Note that for every dollar you put into a U.S. bank account that's subject to reserve requirements (I believe just checking accounts?), the bank can loan out much more than 1 dollar, based on the legally required liquidity ratio or "reserve requirement ratio." Note also that since 2020 that reserve requirement ratio is zero.

whatshisface 4y ago
That is a common misconception that got started as a misunderstanding of Milton Friedman's (reasonable) money multiplier equation. Banks cannot lend more money than they have - if they could, then you could start a bank and multiply your own money. The money multiplication that banks can do is take the money that party B has received for selling something and loan it back to to party A, who can use it to buy something from party B again. A zero percent reserve requirement does not lead in all cases to infinite inflation, because banks are also afraid of a default. Bank's desire to avoid defaults adds another fraction to their reserve ratio and limits money multiplication even when the Fed would technically allow it to proceed infinitely. Another thing you should know is that Fed chairmen have said that Friedman's equation underestimates bank's ability to create money, because in practice the Fed will allow any bank that desires liquidity to borrow it. The Fed, especially post-great-depression, will happily loan banks however much they needed to cover their reserve requirements, meaning that even before the ratio was set at zero, the number of times a single dollar could be spent was decided primarily by a balance of interest rates and fear of defaults.
- tshaddox 4y ago
  Is there a misconception in the text of my previous comment? You seem to be describing a misconception that as far as I can tell isn't one I hold or one I expressed in my previous comment.
  - stonemetal12 4y ago
    > loan out much more than 1 dollar They can't loan out more than the deposits they have.
    - charcircuit 4y ago
      Why not? A bank could have 0 depsitors, but could have received money from investors.
      - majormajor 4y ago
        That's not the sort of bank being talked about here in terms of "money multiplication." That's more like a VC firm or other institution. If you could open a bank, accept 10 dollars in deposits, and loan out 100, you'd do it! You'd loan it out to your best friend and keep the cycle going until you're rich AF. You can't loan out more than you have, but even loaning out 10 of 10 dollars has some risk - if someone comes for their money and you can't get your money back from the people you loaned it to. And it definitely increases money in circulation since it's not parked there. But it's not a magic money printing machine.
      - stonemetal12 4y ago
        The Federal Reserve says you may loan out 100% of your deposits. They didn't say you could loan out however much you have in investors' money, or 200% of your deposits.
  - lottin 4y ago
    The misconception in your comment is that the reserve requirement is what limits a bank's ability to create money by extending loans.
    - tshaddox 4y ago
      I'm no expert, and I know that banking is a lot more complicated in practice, and that reserve requirements in the U.S. (even before they went to zero) were apparently not a significant factor in what actually put a ceiling on banks' ability to lend. There were apparently all sorts of tricks banks used to not be bound in practice to reserve requirements.
- philipbjorge 4y ago
  Can you share some resources where I can learn about this? Thanks
jcranmer 4y ago
The reserve requirement ratio does not do what you think it does. It is the amount of money that the bank is required to keep in its account at a Federal Reserve Bank as a ratio of deposits. Note that literal cash sitting in a vault does not count one iota towards satisfying this reserve ratio. Bank regulations have moved one from having such a specific requirement. Nowadays, you essentially need a minimum amount of equity per risk-weighted assets. So you need something like $8 in cash for every $100 in loans you give out.

whatshisface 4y ago

That is a common misconception that got started as a misunderstanding of Milton Friedman's (reasonable) money multiplier equation. Banks cannot lend more money than they have - if they could, then you could start a bank and multiply your own money. The money multiplication that banks can do is take the money that party B has received for selling something and loan it back to to party A, who can use it to buy something from party B again. A zero percent reserve requirement does not lead in all cases to infinite inflation, because banks are also afraid of a default. Bank's desire to avoid defaults adds another fraction to their reserve ratio and limits money multiplication even when the Fed would technically allow it to proceed infinitely. Another thing you should know is that Fed chairmen have said that Friedman's equation underestimates bank's ability to create money, because in practice the Fed will allow any bank that desires liquidity to borrow it. The Fed, especially post-great-depression, will happily loan banks however much they needed to cover their reserve requirements, meaning that even before the ratio was set at zero, the number of times a single dollar could be spent was decided primarily by a balance of interest rates and fear of defaults.

tshaddox 4y ago
Is there a misconception in the text of my previous comment? You seem to be describing a misconception that as far as I can tell isn't one I hold or one I expressed in my previous comment.
- stonemetal12 4y ago
  > loan out much more than 1 dollar They can't loan out more than the deposits they have.
  - charcircuit 4y ago
    Why not? A bank could have 0 depsitors, but could have received money from investors.
    - majormajor 4y ago
      That's not the sort of bank being talked about here in terms of "money multiplication." That's more like a VC firm or other institution. If you could open a bank, accept 10 dollars in deposits, and loan out 100, you'd do it! You'd loan it out to your best friend and keep the cycle going until you're rich AF. You can't loan out more than you have, but even loaning out 10 of 10 dollars has some risk - if someone comes for their money and you can't get your money back from the people you loaned it to. And it definitely increases money in circulation since it's not parked there. But it's not a magic money printing machine.
    - stonemetal12 4y ago
      The Federal Reserve says you may loan out 100% of your deposits. They didn't say you could loan out however much you have in investors' money, or 200% of your deposits.
- lottin 4y ago
  The misconception in your comment is that the reserve requirement is what limits a bank's ability to create money by extending loans.
  - tshaddox 4y ago
    I'm no expert, and I know that banking is a lot more complicated in practice, and that reserve requirements in the U.S. (even before they went to zero) were apparently not a significant factor in what actually put a ceiling on banks' ability to lend. There were apparently all sorts of tricks banks used to not be bound in practice to reserve requirements.
philipbjorge 4y ago
Can you share some resources where I can learn about this? Thanks

jcranmer 4y ago

The reserve requirement ratio does not do what you think it does. It is the amount of money that the bank is required to keep in its account at a Federal Reserve Bank as a ratio of deposits. Note that literal cash sitting in a vault does not count one iota towards satisfying this reserve ratio. Bank regulations have moved one from having such a specific requirement. Nowadays, you essentially need a minimum amount of equity per risk-weighted assets. So you need something like $8 in cash for every $100 in loans you give out.