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Reserve Bank of Australia response to an open letter about fractional reserve banking and full reserve banking

RESERVE BANK OF AUSTRALIA
65 Martin Place
Sydney NSW 2000

GPO Box 3947
Sydney NSW 2001

Information Department

T: (02) 9551 9830
F: (02) 9551 8033
E: [email protected]
www.rba.gov.au

4 June 2012

Mr David Collett
XXXXXXXX
Newport VIC 3015

Dear Mr Collett

Thank you for your letter dated 30 April 2012.

It is common for broad money to grow faster, in dollar terms, than currency. The difference is mainly driven by a process called ‘money multiplication’, described in most macroeconomic textbooks (1).

To use an example, if you invest $100 of newly minted cash in a bank deposit, your new deposit balance counts as money. If the bank then lends the $100 to, say, a business, most of these funds will return to the banking system as deposits. Consequently, the increase in broad money in dollar terms can be considerably larger than the increase in currency. The bank, the person and the business have interacted to create the additional money.

The process can be reversed. For example, if the household sector chooses to increase its holdings of notes and coins relative to its bank deposits, there is a decrease in the liabilities of the banking system and consequently the assets that it can fund.

The creation of money is not directly regulated, though the Reserve Bank of Australia does influence it heavily through changes in the cash rate which, in turn, influences bank lending rates and the appetite for borrowing and the provision of deposits.

Yours Sincerely,

Christopher Collins
Manager, Media and Public Relations Office

See, for example, Mishkin FS (2009), ‘The Economics of Money, Banking, and Financial Markets’, Pearson Education, pp 345-373.