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In: Economics

Discuss a) the monetary base, b) the money multiplier, and c) the money supply. How do...

Discuss a) the monetary base, b) the money multiplier, and c) the money supply. How do these variables interrelate and interact with each other?

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Expert Solution

a) Monetary base or high power money: monetary base is the total amount of money that is either in general circulation in the hands of public or in the commercial banks deposite held in the central bank's reserves. Monetary based consists of the total currency circulating in the public plus the non bank deposites with commercial bank . It the base of money supply.

b) Money multiplier: It is the amount of money that bank generates with each doller of reserves. Reserved is the amount of deposites that the Fed Reserve require to hold by bank not to lend. This reserve is the ratio of reserve to the total amount of deposits. Thus money multiplier is the ratio of deposite to reserves in the banking system.

c) Money supply: In economics , the money supply is the total stock of currency avaiable at a particular point of time in an economy which includes currency held by public & demand deposite.

This three variable are interlink and interdependent , money supply is determined by monetary base and money multiplier.If we know the value of money multiplier we can predict how much money will change when there is a change in the amount of monetary base or high power money. High power money will bring about changes in the money supply.This relation can be shown as M/H= 1+k/r+k , where M= money supply , H= high power money or monetary base, 1+k/r+k= money multiplier, r= cash reserve ratio of bank , k= currency -deposite ratio of the public. Thus money supply depend on the value of monetary base and money multiplier.

Rahul Sunny answered 2 years ago
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