Question

Q. How do chartered banks create money? what limits the quantity of money that the banking system can create? explain using illustration and examples?

Answer 1

The chartered banks need to keep only a fraction of transactions deposits on reserve and the remainder can be lend out. When a loan is processed then the proceeds would be deposited into the banking system thus creating new transactions deposits. These deposits would make an addition to the money supply.; and the chartered banks are required to keep a fraction of the new deposit as required reserves; and balance can be lend out for the additional loans; thus creating additional transactions deposits

The monetary base size limits the total quantity of money that the chartered banks create can create because they have a desired level of reserves. Also the firms and households have desired currency holdings; both of them desired holdings of monetary.

For example: the maximum predicted money supply change from an increase in the monetary base is multiplied by multiplier. The money multiplier determines the limit on how much money can be created by a chartered bank; thus indicating that the banks can't create unlimited money.