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  • 2.1 Multiplier Effect

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    Rix Aw
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    The multiplier effect describes how an initial deposit in a bank can create a greater total amount of deposits in the banking system. If the reserve requirement is 20%, and a customer deposits $100, the bank can lend out $80 while keeping $20 in reserves. As other customers deposit that $80 and banks continue lending portions of deposits, the initial $100 deposit can eventually create $500 total across the banking system through successive rounds of lending and depositing. The higher the reserve requirement, the lower the multiplier effect; the lower the reserve ratio, the greater money creation through the multiplier process.

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    The multiplier effect describes how an initial deposit in a bank can create a greater total amount of deposits in the banking system. If the reserve requirement is 20%, and a customer deposits $100, the bank can lend out $80 while keeping $20 in reserves. As other customers deposit that $80 and banks continue lending portions of deposits, the initial $100 deposit can eventually create $500 total across the banking system through successive rounds of lending and depositing. The higher the reserve requirement, the lower the multiplier effect; the lower the reserve ratio, the greater money creation through the multiplier process.

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    16 views1 page

    2.1 Multiplier Effect

    Uploaded by

    Rix Aw
    The multiplier effect describes how an initial deposit in a bank can create a greater total amount of deposits in the banking system. If the reserve requirement is 20%, and a customer deposits $100, the bank can lend out $80 while keeping $20 in reserves. As other customers deposit that $80 and banks continue lending portions of deposits, the initial $100 deposit can eventually create $500 total across the banking system through successive rounds of lending and depositing. The higher the reserve requirement, the lower the multiplier effect; the lower the reserve ratio, the greater money creation through the multiplier process.

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    Q 2: Explain multiplier.

    2.1 Multiplier effect

    The multiplier effect depends on the set reserve requirement. So, to calculate the impact of the
    multiplier effect on the money supply, we start with the amount banks initially take in through
    deposits and divide this by the reserve ratio. If, for example, the reserve requirement is 20%, for
    every $100 a customer deposits into a bank, $20 must be kept in reserve. However, the
    remaining $80 can be loaned out to other bank customers. This $80 is then deposited by these
    customers into another bank, which in turn must also keep 20%, or $16, in reserve but can lend
    out the remaining $64. This cycle continues - as more people deposit money and more banks
    continue lending it - until finally the $100 initially deposited creates a total of $500 ($100 / 0.2)
    in deposits. This creation of deposits is the multiplier effect.

    The higher the reserve requirement, the tighter the money supply, which results in a lower
    multiplier effect for every dollar deposited. The lower the reserve requirement, the larger the
    money supply, which means more money is being created for every dollar deposited.

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