Money Creation Banks create money by making loans. A bank loans or invests its excess reserves to earn more interest. A one-dollar increase in the monetary base causes the money supply to increase by more than one dollar. The increase in the money supply is the money multiplier.
The money multiplier tells you the maximum amount the money supply could increase based on an increase in reserves within the banking system. The formula for the money multiplier is simply 1/r, where r = the reserve ratio. A little too easy, right? It's the reciprocal of the reserve ratio.
It is the ratio of the amount of a bank's checkable deposits—demand accounts against which checks, drafts, or other financial instruments can be negotiated—to its reserve amount. So if the deposit multiplier is 80%, the bank must keep $1 in reserve for every $5 it has in deposits.
The money multiplier is the amount the money supply expands with each dollar increase in reserves. The Fed has direct control only over the monetary base.
Solution: Money multiplier is the number by which total deposits can increase due to a given change in deposits. It is inversely related to legal reserve ratio.
Answer and Explanation: 1. If the reserve ratio is 20 percent, the money multiplier is c. 5.
The bank's reserve requirement ratio determines how much money is available to loan out and therefore the amount of these created deposits. The deposit multiplier is then the ratio of the amount of the checkable deposits to the reserve amount. The deposit multiplier is the inverse of the reserve requirement ratio.
The money multiplier is the number by which a change in the monetary base is multiplied to find the resulting change in the quantity of money. Change in quantity of money = Money multiplier X Change in monetary base. The money multiplier is determined by the required reserve ratio (r) and by the currency drain (c).
Money multiplier is expressed as a ratio between broad money and base money. For example, the base money as on March 31, 2017 was Rs 19405.97 billion, whereas broad money was Rs 121815.26 billion. This means a money multiplier of 6.2.
The size of the multiplier depends on the percentage of deposits that banks are required to hold as reserves. When the reserve requirement decreases, the money supply reserve multiplier increases and vice versa.
The monetary multiplier is k = 1/(1− required reserve ratio). Thus, a decrease in the required reserve ratio will result in an increase in the multiplier because each bank will need to hold less reserves and therefore can make more loans.
The actual money multiplier will be less, because some banks hold excess reserves. A reduction in the amount of money that is used for lending that reduces the money multiplier. It is caused by banks choosing to hold excess reserves and from individuals and businesses choosing to hold more cash.