Question

1. If the reserve requirement (rr) is 0.2, what is the simple deposit multiplier? If, in addition, the currency deposit ratio (c) is 0.05 and the excess reserve ratio (e) is 0.15, what is the money multiplier? Explain why the money multiplier differs from the simple deposit multiplier.

Answer 1

Reserve Requirement (rr) = 0.2,

the simple deposit multiplier (m) is the inverse of the rr ratio.

It means m = 1 / rr

= 1 / 0.2

= 5.

(m) = 5.

Given, currency deposit ratio (c) = 0.05

Excess reserve ratio (e) = 0.15

reserve requirement (rr) = 0.2

money multiplier = (1 +c)/(c +rr +e)

= (1 +0.05)/(0.05 +0.15+0.2)

= 1.05/0.4

= 2.625.

So money multiplier = 2.625.

The MM has a relationship between the reserves in a banking system and the money supply. The MM discloses to you the maximum amount the supply of money could increase based on an increase in reserves within the whole of the banking system. Be that as it may, the money multiplier contrasts from the more simple deposit multiplier because banks tend to keep excess reserves, and bank clients tend to change over some portion of checkable deposits to cash. Banks usually keep excess reserves past the minimum reserve requirements predetermined by the Governing or Central Bank. This activity decreases the checkable deposits amount and the total supply of money that is created.

The simple deposit multiplier gives basis to MM. In any case, the money multiplier value is ultimately less, because of excess reserves, savings and transformations to cash by customers.