Question

Explain why a single commercial bank can safely lend only an amount equal to its excess reserves but the commercial banking system can lend by a multiple of its excess reserves. What is the monetary multiplier, and how does it relate to the reserve ratio?

Answer 1

A single commercial bank cannot lend more than its reserves because if checks are written for a higher amount than those reserves, the commercial bank will lose its reserves.

On the other hand, in a fractional reserve system, the system as a whole cannot lose reserves because they are backed up by other banks.

Finally, the relationship between the monetary multiplier and the reserve ratio is inversely proportional. If the reserve ratio goes up, the money multiplier will go down because banks will have less money available to loan, and therefore, will create a lesser amount of money.