MONEY MULTIPLIER Flashcards
What is the money multiplier?
The money multiplier measures how much the total money supply can increase in response to a change in the initial amount of high-powered money. It’s a key concept related to fractional reserve banking.
Explain how fractional reserve banking enables the money multiplier effect.
In fractional reserve banking, banks only hold a portion of deposits as reserves. The rest is lent out. These loans become deposits in other banks, which can then lend out a portion of those deposits. This chain reaction multiplies the initial deposit, expanding the money supply.
What is the relationship between the Cash Reserve Ratio (CRR) and the money multiplier?
They have an inverse relationship. A lower CRR means banks hold less in reserves and can lend more, leading to a larger money multiplier. A higher CRR does the opposite, decreasing the money multiplier.
Give two real-world factors that can influence the size of the money multiplier.
Banking penetration: If people have limited access to banks and hold more cash, the multiplier effect is weaker.
Economic conditions: In a boom, higher loan demand boosts the multiplier; in a downturn, it decreases.
A country’s central bank lowers the CRR from 8% to 5%. Describe the likely impact on the money supply and the money multiplier.
The money supply is likely to increase as banks have more to lend out. The money multiplier will also increase. (Calculate the new money multiplier for extra practice: 1 / 0.05 = 20)
What is high-powered money (or the monetary base)?
High-powered money refers to the most basic form of currency in a system. It includes currency in circulation and commercial banks’ reserves held with the central bank.
Why is the real-world money multiplier often lower than its theoretical maximum?
Several factors can limit the multiplier in practice:
Leakages: People might hold some cash rather than depositing it all.
Excess reserves: Banks may choose to hold reserves above and beyond the required CRR.
Loan demand: If borrowers are reluctant, even available funds might not be fully lent out.
How does central bank monetary policy influence the money multiplier?
Expansionary policy: Lowering CRR, buying bonds, etc., increase the monetary base and banks’ lending capacity, boosting the multiplier.
Contractionary policy: Raising CRR, selling bonds, etc., decrease the monetary base and limit lending, decreasing the multiplier.
True or False: The money multiplier will always be greater than 1 in a functional economy with fractional reserve banking.
True. With fractional reserve banking, even a small reserve ratio allows for some degree of money creation through lending.
Besides the CRR, what is one other tool a central bank can use to influence the money supply?
Open market operations (buying/selling government bonds)
Interest rates on reserves
Discount rate (interest charged to banks borrowing from the central bank)
How did the money multiplier change between 2019 and 2021? Why?
The money multiplier declined from 5.6 on 31/3/2020 to 5.2 on 31/03/2021. This occurred because banks slowed down their lending activity to households and businesses during the COVID-19 pandemic and its aftermath.
Why is the lending-to-deposit activity of banks crucial for the money multiplier?
When banks lend out money, it gets deposited into other bank accounts. These deposits can then be used for further lending. This cycle of lending and depositing leads to an expansion of the money supply, increasing the money multiplier.
How did the money multiplier trend change in 2021-2022?
Between 2021 and 2022, the money multiplier stabilized. It went from 5.2 in 2021 to 5.1 in 2022.
What is the money multiplier, and how is it measured?
The money multiplier is a measure of how much the money supply can expand with each unit of currency held in reserves by banks. It’s measured as the ratio of broad money (M3) to base money (M0).
Describe the trend of the money multiplier between the mid-1990s and 2016-17.
The money multiplier (M3/M0) increased mostly during the period between the mid-1990s and 2016-17.
