An economic question about money supply Help! Thanks!!! Watch

Lotus.An
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tommartin29
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I assume you want an answer?

The way a government finances its budget deficit is through borrowing, but only sales of government securities to the central bank add to the money supply. This is because to buy government securities the private sector must use its own money that is already in supply, therefore it is not new money supply.

So you take the 50bn that the central bank has created. They then lend this out to retail banks and therefore they lend it to consumers and the money supply increases. Because they only have to keep 10% as an asset, they can lend the rest out. To work out how much money is created you take the original 50bn and divide it by 10%, and you get 500bn (this is called the money multiplier)
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Lotus.An
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(Original post by tommartin29)
I assume you want an answer?

The way a government finances its budget deficit is through borrowing, but only sales of government securities to the central bank add to the money supply. This is because to buy government securities the private sector must use its own money that is already in supply, therefore it is not new money supply.

So you take the 50bn that the central bank has created. They then lend this out to retail banks and therefore they lend it to consumers and the money supply increases. Because they only have to keep 10% as an asset, they can lend the rest out. To work out how much money is created you take the original 50bn and divide it by 10%, and you get 500bn (this is called the money multiplier)
Thank you very much.

However, I do not really understand how do you link this financing deficit to money supply. Also, why is 50nb the reserve in central bank? it is used to buy government bonds, so it cannot store in bank as reserves.
I hope you can see what I mean. I am very stupid. Hope you can correct my wrong thoughts.
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tommartin29
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(Original post by Lotus.An)
Thank you very much.

However, I do not really understand how do you link this financing deficit to money supply. Also, why is 50nb the reserve in central bank? it is used to buy government bonds, so it cannot store in bank as reserves.
I hope you can see what I mean. I am very stupid. Hope you can correct my wrong thoughts.
Okay so to be able to finance the debt the government turns to the central bank. The central bank do not use their reserves to fund this, they just create more money and them buy them with this created money. This means there is more money supply as the central bank has created money.
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Lotus.An
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(Original post by tommartin29)
Okay so to be able to finance the debt the government turns to the central bank. The central bank do not use their reserves to fund this, they just create more money and them buy them with this created money. This means there is more money supply as the central bank has created money.
but why this 50bn is divided by 10%
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tommartin29
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(Original post by Lotus.An)
but why this 50bn is divided by 10%
Oh, that is called the money multiplier and is just an equation for calculating the actual amount of money created through fractional reserve banking.

The formula is 1/reserve ratio

therefore you do 1/10% and that equals 10.

50bn x 10 = 500bn.
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Lotus.An
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(Original post by tommartin29)
Oh, that is called the money multiplier and is just an equation for calculating the actual amount of money created through fractional reserve banking.

The formula is 1/reserve ratio

therefore you do 1/10% and that equals 10.

50bn x 10 = 500bn.
I see!!! Thank you so so so so much !!!!!
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