deposit multiplier

(noun)

The maximum amount of commercial bank money that can be created by a given unit of reserves.

Related Terms

Examples of deposit multiplier in the following topics:

  • Example Transactions Showing How a Bank Can Create Money

    • The amount of money created by banks depends on the size of the deposit and the money multiplier.
    • Mathematically, the relationship between reserve requirements (rr), deposits, and money creation is given by the deposit multiplier (m).
    • The deposit multiplier is the ratio of the maximum possible change in deposits to the change in reserves.
    • In the above example the deposit multiplier is 1/0.1, or 10.
    • Calculate the change in money supply given the money multiplier, an initial deposit and the reserve ratio

  • Multiple Deposit Expansion and Contraction

    • We call this formula the simple deposit multiplier, which equals ( 1 ÷ rr ).
    • Simple deposit multiplier shows the maximum increase of the money supply for a change in bank reserves.
    • Simple deposit multiplier assumes the banks lend all their excess reserves.
    • Leakages cause the money multiplier to be smaller in the real world.
    • If banks held onto the entire excess reserves, the money multiplier would equal one.

  • The Reserve Ratio

    • Banks assume responsibility for consumer deposits and make money by loaning out deposited finds.
    • Therefore, banks with relatively higher deposits are able to supply a larger amount of loanable funds.
    • Money growth in the economy can occur through the multiplier effect resulting from the reserve ratio.
    • For example, a reserve ratio of 20% will result in 80% of any given initial deposit being loaned out and if the process of loaning is assumed to continue, the maximum increase in money expansion specific to an initial deposit at a 20% reserve ratio will be equal to the reserve multiplier 1/(reserve ratio) x the initial deposit.
    • For example, with the reserve ratio (RR) of 20 percent, the money multiplier, m, will be calculated as:

  • The Money Supply Multipliers

    • Money multiplier becomes the term within the brackets.
    • Money multiplier equals 2.8.
    • Although the money multiplier relates the total monetary base to the money supply, the money multiplier also works for changes in the monetary base.
    • We derive the money supply multiplier for M2 similarly.
    • The M2 money multiplier exceeds the M1 always.

  • Answers to Chapter 11 Questions

    • Money multiplier shows how the money supply changes, when the monetary base changes.
    • Consequently, the public, banks, and the Fed all influence the money multiplier.
    • Currency-to-deposit ratio represents the portion of money held by the public as currency.
    • Thus, the multiple deposit creation ceased to work.
    • We calculated both the M1 and M2 money multipliers below:

  • Multiple Investments

    • For instance, you deposit $500 into the bank account every year at 6% interest.
    • We calculate the future value of your bank deposits in Equation 8.
    • Last term in Equation 8 is the final deposit.Although you multiply this term by an interest rate, the exponent equals zero setting the term inside the parenthesis to a one.
    • Withdrawal or deposit determines the sign.
    • A withdrawal is negative, while a deposit is positive.

  • Reserve Requirement

    • Money multiplier (1 ÷ rr) increases if the Fed reduces the reserve requirement, and vice versa.
    • Unfortunately, the banks hold fewer than 10% of the deposits as vault cash and/or deposits at the Fed.
    • Reserve requirement ratios are components of the money multiplier.
    • No empirical evidence indicates reserve requirements improve the stability of the money multiplier.
    • Banking system could not create multiple deposit expansion, and the money multiplier would be one.

  • Chapter Questions

    • Defines the money multiplier and identify the parties who influence the money multiplier.
    • Calculate the change in the M1 definition of the money supply if a person deposits $1,000 in cash into his checking account.
    • Identify the currency-deposit ratio, and explain why it changes over time.
    • Currency in circulation equals $500 billion; checkable deposits equal $900 billion; total bank reserves are $700 billion, and total time deposits equal $1,200 billion.
    • Calculate the M1 and M2 money multipliers.

  • The Money Multiplier in Reality

    • In reality, it is very unlikely that the money supply will be exactly equal to reserves times the money multiplier.
    • In reality, not all of these are true, meaning that the observed money multiplier rarely conforms to the theoretical money multiplier.
    • Second, customers may hold their savings in cash rather than in bank deposits.
    • Imagine that the reserve requirement ratio is 10% and a customer deposits $1,000 into a bank.
    • The bank then uses this deposit to make a $900 loan to another one of its customers.

  • The Money Multiplier in Theory

    • The money multiplier measures the maximum amount of commercial bank money that can be created by a given unit of central bank money.
    • In order to understand the money multiplier, it's important to understand the difference between commercial bank money and central bank money.
    • The money multiplier measures the maximum amount of commercial bank money that can be created by a given unit of central bank money.
    • We can derive the money multiplier mathematically, writing M for commercial bank money (loans), R for reserves (central bank money), and RR for the reserve ratio.
    • We start with the reserve ratio requirement that the the fraction of deposits that a bank keeps as reserves is at least the reserve ratio: