How+Lending+Creates+Money


 * How Lending Creates Money**


 * The Bank of Canada has the job of implementing and managing Monetary Policy for the country. One of the ways inwhich it acheives this task is by creating lending along with the chartered banks too essentially inject money into the economy at a more rapid rate than dollar for dollar. This is achieved by the money multiplier effect which will be explained below. First, we will consider the role of the Bank of Canada in lending that will create money in the economy and then we will look at the process by which it takes place.**

**The Hierarchy of the lending bodies in Canada is as follows:**
 * ** · THE BANK OF CANADA**
 * ** · CHARTERED BANKS**
 * ** · NEAR BANKS - These " near banks" also lend but do not count in the money supply as they are not part of the Bank of Canada.**
 * The Bank of Canada sets the following policies/rates:**
 * ** · TARGET RESERVE – This is set according to the Target Reserve Ratio, which is the portion of deposits that a bank wants to hold in cash. (0% in Canada right now)**
 * ** · OVERNIGHT RATE – the rate at which banks borrow from one another (1.00% in Canada right now)**
 * ** · BANK RATE – the Rate at which banks may borrow from the Bank of Canada (lender of last resort) (1.25% in Canada right now – always ¼% higher than the overnight rate.**

An excellent website to visit to look at these rates daily as well as a huge source of information on monetary policies please visit the Bank of Canada website. Link below. [|Bank of Canada]

__How lending Creates Money:__ **1. Starts with Demand Deposits (amounts held in personal chequing accounts)** **2. Target Reserve – set by the Bank of Canada determines the amount of cash that a bank wants to hold in cash** **3. Target Reserve Ratio - % of demand deposits a bank wants to hold in cash** **4. TARGET RESERVES=TARGET RESERVE RATIO** **(0% in Canada)** **X DEMAND DEPOSITS** **5. Determine excess Reserves – Amount of cash held by bank in addition to the target reserve. “Excess reserves are used for loans”** **6. All of this information will create the** MONEY MULTIPLIER **that will give us an additional $1.00 of demand deposits will increase the money supply.**

__For example:__
MONEY MULTIPLIER = ∆ deposits ÷ ∆ reserves = 1 ÷ target reserve ratio MONEY MULTIPLIER IS 2.5 IF YOU DEPOSITED $100.00 INTO YOUR CHEQUING ACCOUNT OVER TIME IT WILL BE LENT OUT OVER AND OVER. WITH THE COMPOUNDING MULTIPLIER EFFECT IT BECOMES $250.00 BEING AVAILABLE TO BE LENT OUT. THE ORIGINAL $100.00, ORIGINALLY CREATES $60.00 IN LENDING FUNDS AVAILABLE AND FROM THAT $60.00, $36 WILL GET LENT OUT, FROM THAT $36.00, $21.60 WILL GET LENT OUT, FROM THAT $21.60, $12.96 WILL GET LENT OUT ETC ETC ETC.... UNTIL THE AMOUNT AVAIL TO LEND COMES TO ZERO. AT THAT TIME IF WE ADDED ALL THE AMOUNTS THAT WE HAD AVAILABLE TO BE LENT OUT FROM THE ORIGINAL $100.00, THOSE AMOUNTS WOULD TOTAL $250.00.
 * Target Reserve = $40,000 Demand Deposits = $100,000**
 * __40000___ X 100 = 40% = __1__ = 2.5 **
 * 100000 .40**


 * If you have been given a loan, you may choose many ways to spend that money. Either way it places $250.00 in to the economy and will potentially increase overall GDP. Thereby lending directly places money into the economy at a rate of 2.5.**