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Money Creation (1)

The document discusses the banking system's role in money supply and credit creation, highlighting how commercial banks create money through deposit expansion and lending under a fractional reserve system. It explains the concept of money supply, its measurement, and the money multiplier effect, as well as the central bank's influence through monetary policy tools. Understanding these mechanisms is crucial for achieving macroeconomic stability.

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justusnyamaiamin
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12 views

Money Creation (1)

The document discusses the banking system's role in money supply and credit creation, highlighting how commercial banks create money through deposit expansion and lending under a fractional reserve system. It explains the concept of money supply, its measurement, and the money multiplier effect, as well as the central bank's influence through monetary policy tools. Understanding these mechanisms is crucial for achieving macroeconomic stability.

Uploaded by

justusnyamaiamin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 7

Money Supply and Credit Creation by the Banking

System

Nelson Kemboi

Moi University
ACS303: Macroeconomics

February 3, 2025

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 1/7
Introduction

The banking system plays a crucial role in determining the money


supply.
Commercial banks create money through the process of credit
creation.
The central bank influences money supply via monetary policy tools.

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 2/7
Definition of Money Supply

Money supply refers to the total stock of money circulating in an


economy.
Measured using different aggregates:
M0 - Reserve money (currency in circulation + reserves)
M1 - Currency + demand deposits
M2 - M1 + savings and time deposits
M3 - M2 + large time deposits

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 3/7
Money Creation by Banks

Banks create money through deposit expansion and lending.


Based on the fractional reserve banking system.
Governed by the money multiplier effect.

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 4/7
Money Multiplier Effect

The money multiplier (m) is given by:

1
m=
r
where r is the required reserve ratio.
Example: If r = 10%, then m = 10.
A deposit of 1,000 KES leads to a maximum money creation of:

1, 000 × 10 = 10, 000 KES

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 5/7
Role of the Central Bank

The central bank regulates money supply using:


Open Market Operations (buying/selling bonds)
Reserve Requirements (changing reserve ratios)
Discount Rate (interest rate for lending to banks)

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 6/7
Conclusion

Commercial banks play a key role in credit creation.


The money supply is influenced by the central bank’s monetary policy.
Understanding money supply helps in macroeconomic stability.

Nelson Kemboi (Moi University ACS303: Macroeconomics)


Money Supply and Credit Creation by the Banking SystemFebruary 3, 2025 7/7

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