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Chapter 14: Problem 20

What is the formula for the money multiplier?

Short Answer

Expert verified
The basic formula for the money multiplier (MM) is: \(MM = \frac{1}{RR}\), where RR represents the reserve ratio as a fraction.

Step by step solution

01

Define the Reserve Ratio

Reserve ratio (RR) is the percentage of deposits that banks are required to hold as reserves, either by regulation or by their own policy. It is expressed as a fraction, so if the reserve ratio is 20%, it will be represented as 0.2.
02

Calculate the Money Multiplier using the reserve ratio

The basic formula for the money multiplier (MM) is: \[MM = \frac{1}{RR}\]
03

Example

Let us consider an example where the reserve ratio is 20% (or 0.2). Using the formula from step 2, we can calculate the money multiplier: \[MM = \frac{1}{0.2}\]
04

Solve for the Money Multiplier

Continuing with the example from step 3, calculate the money multiplier: \[MM = 5\] This means that for every 1 unit of currency deposited in the banking system, the money multiplier (in this example) will create a total of 5 units of currency in the economy, through various loans and deposits.

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Most popular questions from this chapter

How do banks create money?

How does the existence of money simplify the process of buying and selling?

Explain what will happen to the money multiplier process if there is an increase in the reserve requirement?

How can a bank end up with negative net worth?

Why do we call a bank a financial intermediary?
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