Money Multiplier

Money Multiplier Simple Definition

In simple words, money multiplier is ratio of actual and initial deposit and reserve ratio. Money multiplier is used in banks. For example, a depositor comes and deposited Rs. 100 in bank, bank's reserve rate is 10%. Now, bank will calculate Rs. 10 as reserve and rest Rs. 90 will issue as loan. This process will continue under fractional reserve banking. But before this, bank will be interested to know his capacity to increase deposit with initial deposit amount of Rs. 100 which we can calculate through money multiplier formula

Money Multiplier (M) = Actual and Initial Deposit Amount / Reserve Ratio 

=  Rs. 100 / 10% or = 100/0.10 = Rs. 1000

Bank can get deposit of different persons through first deposit of Rs. 100. Rs. 1000 is 10 times of Rs. 100. For this, bank can get idea of his future power.

We also know Money multiplier as reverse of reserve rate. For example, we can say 10% rate is 1/10.

Money multiplier = total initial deposit amount / reserve rate

Now we can also say = 1/ reserve rate

= 1/1/10 = 10 which is just equal to the result which we calculated in above example.

Effect of Money Multiplier in Expanding the Money Supply

Money multiplier's calculation is on the basis of reserve ratio, if reserve ratio will be less, bank will have more power to supply money in market through loan. If reserve ratio will be very high. It is just like ban for bank to give more and more money as loan. For example, if rate of reserve increase as is reached at 50%. At that time, money multiplier will be just Rs. 200 which is just 2 times of initial deposit of money. Due to this effect bank will not issue more loan.

Related : Money Laundering

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