Question

What is money multiplier? How will you determine its value? What ratios play an important role in the determination of the value of the money multiplier?

Answer 1

Money multiplier is the amount of money that banks generate with each dollar of reserves. Reserve is the amount of deposits that the federal reserve require to hold not lend.It is the ratio of stock of money to the stock of high powered money in an economy.

$MONEYMULTIPLIER=\frac{1}{REQUIREDRESERVERATIO}$

Mm is the money multiplier

M is stock of money

H represents high powered money

$Mm=\frac{M}{H}$

The value of multiplier is always geater than 1 , it can also be derived as :

$M=C+DD$

$=(1+cdr)DD$

where ,

M= Money supply

C= Currency held by people

cdr= Currency deposit ratio

DD = Demand deposits

High powered money = currency + reserve money

$H=C+R$

$cdrD+rdrD$

$D(cdr+rdr)$

So , $\frac{M}{H}=\frac{1+cdr}{cdr+rdr}$ which is > 1

The currency deposit ratio and reserve deposit ratio plays an important role in determing money multiplier.

The cdr is the ratio of money held by public to that they hold in bank deposits.

The rdr is the proportion of total deposits kept by commercial banks as reserve.