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The Money Multiplier

The money multiplier measures how much the money supply grows due to the banking system creating money through lending. If the multiplier is 10, a $1 increase in monetary base leads to a $10 increase in money supply. The multiplier works by banks lending out most of their deposits, which are then redeposited and lent out again in a multiplying effect. For example, with a 10% reserve requirement and $100 initial deposit, total deposits grow to $1,000 through repeated lending and redepositing, illustrating the multiplier effect.

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244 views1 page

The Money Multiplier

The money multiplier measures how much the money supply grows due to the banking system creating money through lending. If the multiplier is 10, a $1 increase in monetary base leads to a $10 increase in money supply. The multiplier works by banks lending out most of their deposits, which are then redeposited and lent out again in a multiplying effect. For example, with a 10% reserve requirement and $100 initial deposit, total deposits grow to $1,000 through repeated lending and redepositing, illustrating the multiplier effect.

Uploaded by

Bilal Riaz
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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The money multiplier (also called the credit multiplier or the deposit multiplier) is a measure of the extent to which

the creation of money in the banking system causes the growth in the money supply to exceed growth in the monetary base. The multiplier is the multiple by which the expansion in the money supply is greater than the increase in the monetary base: if the multiplier is 10, then a 1 increase in the monetary base will cause a 10 increase in the money supply. Most discussions of the multiplier do not discuss what measure of the money supply is being increased. As it is usually restricted to deposits in banks, this implies that we are talking about M1(most commonly) or M2. Multipliers can also be calculated for broad money measures such as M3and M4. The deposit expansion multiplier The easiest way to understand how the multiplier works is to consider what happens under simplifying assumptions:
y y

Banks keep a fixed fraction of deposits to meet the reserve requirement. Customers of the banks pay each other by cheque (or transfer etc.) but not by withdrawing cash to make payments. When customers do not receive these payments they do not withdraw any of the money from the bank.

Now consider a the following sequence of events 1. An initial deposit is made of 100 2. The bank is able to lend 90 of this. The borrower draws cheques against the 90 balance now in their account that the payees deposit in accounts in the same of other banks. Now customer balances have increased by the original 100 plus the 90 from the new cheque deposits: a total of 190 3. The bank can now lend 90% of the 90, a further 81. 4. Total deposits are now increased by another 81 to to 271 5. This process repeats and the total increase in bank deposits is 10 times the amount initially deposited: i.e. 1,000 As you might infer from the above, the multiplier is the reciprocal of the reserve requirement. If the reserve requirement was (a very high) 20% the multiplier would be 1 0.2 = 5

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