alexmthomas

New member
Didnt like this presentation as much as the 'philips curve' one. This had too much of unnecessary effects and found it confusing to comprehend.
 

johnyy

New member
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To explain the process of credit creation, we make the following assumptions:

1. There are many banks, say А, В, C, etc., in the banking system.

2. Each bank has to keep 10 percent of its deposits in reserves. In other word 10 per cent is the required ratio fixed by law.

3. The first bank has Rs. 1000 as deposits.

4. The loan amount drawn by the customer of one bank is deposited in full in the second bank, and that of the second bank into the third bank, and so on.

5. Each bank starts with the initial deposit which is deposited by the debtor of the other bank.

Given these assumptions suppose that Bank A receives cash deposits of Rs. 1000 to begin with. This is the cash in hand with the bank which is its asset and this amount is also the liability of the bank by way of deposits it holds. Given the reserve ratio of 10 per cent, the bank keeps Rs. 100 in reserves and lends Rs 900 to one of its customers who, in turn, give a cheque to some person from whom he borrows or buys something. The net changes in Bank A’ is balance sheet are +Rs 100 in reserves and +Rs 900 in loans on the assets side and Rs 1000 in demand deposits on the liabilities side as shown in Table 73.1. Before these changes Bank A had zero excess reserves.

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This loan of Rs. 900 is deposited by the customer in Bank B whose balance sheet is shown in Table 73.2. Bank B starts with a deposit of Rs. 900, Keeps 10 per cent of it or Rs. 90 as cash in reserve. Bank B has Rs 810 as excess reserves which it lends thereby creating new deposits.

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This loan of Rs. 810 is deposited by the customer of Bank B into Bank C. The balance sheet of Bank C is shown in Table 73.3. Bank C keeps Rs 81 or 10 per cent of Rs 810 in cash reserves and lends Rs. 729.

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This Process goes on to other banks. Each bank in the sequence gets excess reserves, lends and creates new demand deposits equal to 90% of the preceding bank’s. In this way, new deposits are created to the tune of Rs. 10000 in the banking system, as shown in Table 73.4.

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The multiple credit creation shown in the last column of the above Table can also be worked out algebraically as:

Rs 1000[1+(9/10)+(9/10)2+(9/10)3+…+(9/10)”]

=Rs 1000(1/1-9/10)= Rs 1000(1/1/10)= Rs 1000×10 = Rs 10000.
 
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