Reference no: EM131610751

Question: This problem illustrates how banks create credit and can thereby lend out more money than has been deposited. Suppose that initially $100 is deposited in a bank. Experience has shown bankers that on average only 8% of the money deposited is withdrawn by the owner at any time. Consequently, bankers feel free to lend out 92% of their deposits. Thus $92 of the original $100 is loaned out to other customers (to start a business, for example). This $92 becomes someone else's income and, sooner or later, is redeposited in the bank. Thus 92% of $92, or $92(0.92) = $84.64, is loaned out again and eventually redeposited. Of the $84.64, the bank again loans out 92%, and so on.

(a) Find the total amount of money deposited in the bank as a result of these transactions.

(b) The total amount of money deposited divided by the original deposit is called the credit multiplier. Calculate the credit multiplier for this example and explain what this number tells us.