deposit multiplier

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

• 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 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:

• Other Measurements of the Money Supply

  • MB is the total of all physical currency plus Federal Reserve Deposits (special deposits that only banks can have at the Fed).
  • M1: The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits.
  • M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).
  • M3: M2 + all other certificates of deposit (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements.
  • It is M2 – time deposits + money market funds.

• The Multiplier Effect

  • When the fiscal multiplier exceeds one, the resulting impact on the national income is called the multiplier effect.
  • In economics, the fiscal multiplier is the ratio of change in the national income in relation to the change in government spending that causes it (not to be confused with the monetary multiplier).
  • When the fiscal multiplier exceeds one, the resulting impact on the national income is called the multiplier effect.
  • Although the multiplier effect usually measures values of one, there have been cases where multipliers of less than one are measured.
  • During recessions, the government can use the multiplier effect in order to stimulate the economy.

• Fiscal Policy and the Multiplier

  • Fiscal policy can have a multiplier effect on the economy.
  • In addition to the spending multiplier, other types of fiscal multipliers can also be calculated, like multipliers that describe the effects of changing taxes.
  • The size of the multiplier effect depends upon the fiscal policy.
  • The multiplier on changes in government purchases, 1/(1 - MPC), is larger than the multiplier on changes in taxes, MPC/(1 - MPC), because part of any change in taxes or transfers is absorbed by savings.
  • Describe the effects of the multiplier beyond its relevance to fiscal policy

• Fiscal Levers: Spending and Taxation

  • However, the tax multiplier is smaller than the spending multiplier.
  • The money that is saved does not contribute to the multiplier effect .
  • The government spending multiplier is always positive.
  • In contrast, the tax multiplier is always negative.
  • The tax multiplier is smaller than the government expenditure multiplier because some of the increase in disposable income that results from lower taxes is not just consumed, but saved.

• Measuring the Money Supply: M1

  • More specifically, M1 includes currency and all checkable deposits .
  • Checkable deposits refer to all spendable deposits in commercial banks and thrifts.
  • Imagine that Laura deposits $900 in her checking account in a world with no other money (M1=$900).
  • Mandy deposits the money in a checking account at another bank.
  • The M1 measure includes currency in the hands of the public and checkable deposits in commercial banks.

• How Fiscal Policy Can Impact GDP

  • Expansionary fiscal policy can impact the gross domestic product (GDP) through the fiscal multiplier.
  • The fiscal multiplier (which is not to be confused with the monetary multiplier) is the ratio of a change in national income to the change in government spending that causes it.
  • When this multiplier exceeds one, the enhanced effect on national income is called the multiplier effect.
  • The multiplier effect has been used as an argument for the efficacy of government spending or taxation relief to stimulate aggregate demand.
  • In certain cases multiplier values of less than one have been empirically measured, suggesting that certain types of government spending crowd out private investment or consumer spending that would have otherwise taken place.