money multiplier

(noun)

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

Related Terms

Examples of money multiplier in the following topics:

  • 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.
    • If banks instead lend less than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier.

  • 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.
    • The money multiplier in theory makes a number of assumptions that do not always necessarily hold in the real world.
    • In reality, not all of these are true, meaning that the observed money multiplier rarely conforms to the theoretical money multiplier.
    • If the customer fails to spend this money, it will simply sit in the bank account and the full multiplier effect will not apply.
    • Explain factors that prevent the money multiplier from working empirically as it does theoretically

  • 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.
    • 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:
    • This then signifies that any initial deposit will contribute to an expansion in money supply up to 5 times its original value.

  • Fiscal Levers: Spending and Taxation

    • However, the tax multiplier is smaller than the spending multiplier.
    • This is because when the government spends money, it directly purchases something, causing the full amount of the change in expenditure to be applied to the aggregate demand.
    • The money that is saved does not contribute to the multiplier effect .
    • In contrast, the tax multiplier is always negative.
    • The crowding out effect occurs when higher income leads to an increased demand for money, causing interest rates to rise.

  • Shifts in the Money Demand Curve

    • In economics, the demand for money is the desired holding of financial assets in the form of money.
    • The nominal demand for money generally increases with the level of nominal output (the price level multiplied by real output).
    • The interest rate is the price of money.
    • The real demand for money is defined as the nominal amount of money demanded divided by the price level.
    • Explain factors that cause shifts in the money demand curve, Explain the implications of shifts in the money demand curve

  • Limits of Fiscal Policy

    • Chartalists argue that deficit spending is logically necessary because, in their view, fiat money is created by deficit spending: one cannot collect fiat money in taxes before one has issued it and spent it, and the amount of fiat money in circulation is exactly the government debt – money spent but not collected in taxes.
    • The fiscal 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.
    • How effective fiscal policy is depends on the multiplier.
    • The greater the multiplier, the more effective the policy.

  • 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.
    • The government invests money in order to create more jobs, which in turn will generate more spending to stimulate the economy.
    • Although the multiplier effect usually measures values of one, there have been cases where multipliers of less than one are measured.

  • Present Value and the Time Value of Money

    • The time value of money is the principle that a certain amount of money today has a different buying power (value) than in the future.
    • The time value of money is the principle that a certain amount of money today has a different buying power (value) than the same currency amount of money in the future.
    • This notion exists both because there is an opportunity to earn interest on the money and because inflation will drive prices up, thus changing the "value" of the money.
    • The time value of money is the central concept in finance theory.
    • Assuming a 5% interest rate, $100 invested today will be worth $105 in one year ($100 multiplied by 1.05).

  • 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 money does not disappear, but rather becomes wages to builders, revenue to suppliers, etc.
    • The money spent on construction of a plant becomes wages to builders.