Money+Multiplier

Money Multiplier

Money multiplier is the increase in total deposits that would occur in the whole banking system as a result of a new deposit in a single bank. Money multiplier is determined using:

Money Multiplier= (∆ deposits)/(∆ reserves )

And it is calculated by the formula: Money Multiplier= 1/(target reserve ratio)

Given an example: Target reserve = 50,000 Demand Deposits = 110,000

Determine the target reserve ratio: Target reserve ratio=50,000/110,000 x 100 = 45%

Money Multiplier=1/(45%)=2.22

For every $100 deposited by a customer, 45% ($45.00) will be kept in the bank reserve and the remaining $65 (the excess reseve) can be loaned to another customer. The second customer can deposit the $65 to another bank and the 45% will be kept as a reserve and the remaining 65% the bank can loan it out to another customer. It’s a continuous repeating cycle until this $100 will amount to $222 ($100 x 2.22).

What causes the money multiplier to be bigger or smaller? Raise in target reserve ratio = multiplier ↓ Increase in cash held by household = multiplier ↓ Decrease in the demand for loans = multiplier ↓ Decrease in the number of credit worthy applicants = multiplier ↓ The reverse change of the four factors will shift the multiplier in the opposite direction.

References: Class notes, Economics Morris,Sayre.”The Principles of Macro Economics” 6th edition, pp. 263-264==