The Multiplier of Money

The money supply is multiplied by the monetary base: the money multiplier is 1/f.

The money supply increases by 1/f dollars when the Federal Reserve boosts the monetary base by one dollar. If the reserve requirement is f=.10, for example, the money supply grows by ten dollars and the money multiplier is ten.

The fractional banking system’s money multiplier is an important factor.

1. The number of bank deposits rises initially (monetary base)
2. The bank keeps a portion of the deposit in reserves and then lends the remainder out.
3. This bank loan will be re-deposited in banks, enabling more bank lending and a larger money supply.

Money- Multiplier process:

The money-multiplier process illustrates how an increase in the monetary base leads to a doubled increase in the money supply. Assume the Federal Reserve conducts an open-market operation, in which it creates $100 in order to purchase $100 in Treasury securities from a bank. The monetary basis is increased by one hundred dollars.

Because the bank has $100 in extra reserves, it decides to lend them money to earn interest. The money is used to purchase anything by the borrower.

The vendor gets the $100 and puts it in his bank account. Assume that f=10 is the reserve requirement. The bank holds a reserve of.10*$100=$10 and lends the rest $90 in surplus reserves. The money is used to purchase anything by the borrower.

The $90 is received by the vendor and deposited in his bank account. The bank keeps.10*$90 in reserves and lends the other $81 in surplus reserves. The money is used to purchase anything by the borrower.

The seller receives the $81 and puts it in his bank account, and the transaction is completed.

Evaluation of the Money Multiplier:

The sum of the increases at each phase equals the entire rise in the money supply:

                                                         ∆M= 100+90+81+···  

                                                                = 100+100×.90+100×.902 +··· 

A geometric sum that is infinite.

The formula for an infinite geometric sum produces since the first term is 100 and the ratio of consecutive terms is 1-0f=.90

                                                     ∆M= 100 /1-(1-f)=100/f = 1000.

The money multiplier is thus ten: For every one dollar increase in the monetary base, the money supply expands by 10 times.

The value of the currency depreciates as inflation rises. This is why the RBI keeps track of money supply by categorizing it as ‘reserve money,’ ‘narrow money,’ and ‘broad money’. Money is the most widely used means of exchange (money). Notes, coins, and bank account deposits are all examples of this money. These are also known as legal tender because no citizen in the country may refuse to accept them for transactions. As a result, the economy’s money supply balance is extremely crucial. When the money supply shrinks, prices in the economy begin to fall, which is known as deflation. However, as the amount of money printed increases and the money supply expands, inflation rises. Two elements are required in mind before falling into the money supply in India or anywhere in the world is:

• Currency held by the Public
• Demand deposits held by the Public

The money supply is a stock variable, much as money demands. Money supply refers to the total amount of money in circulation among the general population at any one moment. M1, M2, M3, and M4 are the four money supply measurements released by the RBI. The following are their definitions: