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How Money Works

The Money Multiplier: How $100 Becomes $1,000

Ages 10–14 25 min read Intermediate

In the last lesson you learned banks create money when they lend. But there's a mechanism that takes a single deposit and multiplies it many times over. Economists call it the money multiplier effect.

Your $100 deposit can become $1,000 in the wider economy. Here's how.

The Chain Reaction

  1. You deposit $100 in Bank A.
  2. Bank A keeps 10% ($10), lends $90 to someone.
  3. That $90 gets deposited in Bank B.
  4. Bank B keeps $9, lends $81.
  5. Bank C keeps $8.10, lends $72.90.
  6. And on it goes...

Total deposits created: ~$1,000 from your original $100. Formula: $100 ÷ 0.10 = $1,000.

Is That Real Money?

Everyone in the chain thinks they have money. You have $100. The shop has $90. The next person has $81. Add it up: $1,000 in deposits but only $100 of actual base money. The rest is IOUs on top of IOUs.

This is why bank runs are dangerous — if everyone withdraws at once, the money isn't there.

Reserve Ratios Have Changed

In March 2020, the US Federal Reserve set the reserve requirement to zero. Australia never had a formal reserve ratio — APRA uses capital requirements instead. When the reserve ratio is zero, the theoretical multiplier is infinite.

The 2008 Crisis

Banks multiplied money so aggressively through mortgage lending that when borrowers couldn't repay, the whole chain collapsed. This was the Global Financial Crisis.

Tonight's Question

"If you deposit $100 and the bank lends $90 to someone else, do you still have $100? Does the other person have $90? Where did the extra money come from?"

Both of you think you have money. But the bank only has $10. What if you both went to the ATM?

The Multiplier Chain

Need: 100 tokens/coins, paper, 3+ players.

  1. Give 100 tokens to Player 1.
  2. Player 1 keeps 10, passes 90 to Player 2.
  3. Player 2 keeps 9, passes 81 to Player 3.
  4. Continue until amounts are tiny.
  5. Count: how many total "deposits" exist? Compare to the original 100.

Discuss: who actually has the money? What if everyone needs it back?

Go Further

  • Research: Look up "bank run" — find photos of the Northern Rock bank run (2007, UK).
  • Book: The Ascent of Money by Niall Ferguson (2008).
  • Question: What's the difference between "broad money" (M3) and "base money" (M0)?
  • Australian: What stops Australian banks from creating unlimited money without a reserve ratio?

What We Simplified

  • The textbook multiplier is outdated. Banks don't wait for deposits before lending — they create money directly. The Bank of England said the multiplier model is inaccurate.
  • Capital requirements are the real constraint, not reserves.
  • The multiplier isn't fixed — it changes with lending demand.

Sources

  • McLeay et al. (2014). "Money creation in the modern economy." Bank of England Quarterly Bulletin.
  • Federal Reserve Board (2020). "Reserve Requirements." Link
  • Ferguson, N. (2008). The Ascent of Money. Penguin Press.
  • Carpenter, S. & Demiralp, S. (2012). "Money, Reserves, and the Transmission of Monetary Policy." Journal of Macroeconomics, 34(1), 59-75.

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