Multiple Expansion of Deposits

The multiple expansion of deposits, better known as the deposit multiplier, is how banks make money out of thin air (really though). When you put $100 in your checking account in the U.S., legally the bank has to keep 10% of it on hand, which is the “required reserve ratio.” The other 90% the bank can lend out to other customers (excess reserves) via student loans, a mortgage, a car loan, or a business loan. In this case, that’s $90 your bank can lend out to someone else.

Here’s the magic part: so...you have your $100 deposited in your bank. But your bank also just took $90 of that money and lent it out to someone else, who now has $90 in their pocket. Boom: $190 exists from $100.

What if that person with the $90 in their pocket put it in their bank account? Well, the bank would keep 10% of it, and lend out the other 90%, just like they did with you, creating another boom of new money in someone else’s pocket. And we can keep going down this bada-boom rabbit hole until we can’t go any farther. This is what the central bank tries to estimate and control via monetary policy. Tricky tricky.

We can calculate how much money can be made from that initial $90 (that was lent out from your $100) by using the multiple expansion of deposits, which is always 1-over-the required reserve ratio (for the U.S., that’s 10). So $90 x 10 = $900.

Make sure you don’t get the multiple expansion of deposits confused with the money multiplier, which is similar, but a different thing. The multiple expansion of deposits tells us the maximum possible amount of money that could be created from a given amount of money. The money multiplier is always smaller than the multiple expansion of deposits, which estimates the actual change in a country’s money supply.