Question

Write the simple formula for the money multiplier. If some borrowers hold loan money as cash, is this money multiplier too high or too low. Explain briefly.

Answer 1

1.The simple formula for the money multiplier is 1/r where r = Required reserve ratio (Fixed by Central bank)

When some borrowers hold money in cash it means there is currency drainage in such case money multiplier will be lower.

When there is some currency drainage, money multiplier is calculated as per following formula:

Money multiplier when there is currency drainage= 1 + drainage ratio/required reserve ratio + drainage ratio.

For Example : Assume Country X has required reserve ratio of 30% and a currency drainage(borrowers holding cash) of 15%. Money Multiplier in this case will be :

Money multiplier in X country = (1 + 15%) ÷ (30% + 15%) = 2.56

Assume Country Y has required reserve ratio of 30% with no drainage of currency

Money multiplier in Y country = 1/30% = 3.33

so, Country X (where borrowers are holding cash) has lower money multiplier as compared to Country Y, so Money Multiplier, where some borrowers hold cash Money Multiplier will be lower & higher the amount of cash is held lower the Money multiplier will be.