Money Multiplier

By Laxmi Narasimha Boddu

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Monetary Base – B Reserve-deposit ratio – rr Currency-deposit ratio – cr Money Multiplier – m Money supply – M

Money multiplier
• The money multiplier is a multiplicative factor on the monetary base • M= m*B

• Where  M= Money supply ( M=C+D)  m= Money Multiplier  B= Monetary Base

High Powered Money

Each Unit of the monetary base leads to a money supply larger than 1 Unit.

Our assumption that depositors always leave their money in bank deposits.  Since individuals hold part of their money in terms of currency. In particular we assume that individuals always desire to hold currency proportional to the level of deposits. Similarly as agents withdraw deposits from the banking sector, banks will hold free reserves proportionally to the level of checkable deposits at any time as well

Lets define cr and rr ◦ cr = (C/D) = Currency ratio ◦ rr = (R/D)= Reserve ration  Where “rr” indicates the level of reserve deposit ratio of the banking sector. Note that this is technically a behavioral assumption. We assume that individuals and banks in the aggregate always hold a certain fraction of their “money” in terms of currency and deposit reserves respectively.

B= C+R
B= (cr*D)+(rr*D) =>

D

B cr  rr

M= C+D

M= (cr*D)+D =>

M D  1 cr

From Equations

M

1 cr cr  rr

*B

Money Multiplier
1 cr  Factor of proportionality is cr  rr
denoted by “m” called as money multiplier

M = m*B

As money base increases Money supply increases.  As rr decreases Money supply increase.  As cr decreases Money supply increases.

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