Question

What is the relationship between deposit expansion and the simple deposit multiplier?

What are the problems with the simple deposit multiplier?

Answer 1

Deposit expansion is the process in which banks creates additional money using money already deposited. The money expands because when banks loan it out, it reenters the economy. This is the process of making money by distributing it in the market. The money which is distributed is taken from thed deposits. This is Deposit expansion.

   Deposit multiplier refers to the amount of cash that a bank must keep in its reserve. Every bank is supposed to keep some reserve in their account for meeting sudden obligation.The deposit multiplier is normally a percentage of the amount on deposit at the bank. The deposit multiplier requirement is key to maintaining an economy's basic money supply.

Here also the same process like the deposit expansion is happemd that the bank uses the deposit money to stabilise the economy. But the difference is that in deposit expansion bank distribute the money to the market and make from it but in case of deposit multiplier bank use this deposit for making some reserve out of it.

PROBLEMS WITH SIMPLE DEPOSIT MULTIPLIER

There are some problems are there when the bank use deposit multiplier. The main one is that how much risk the bank takes. It means banks have to lend money or wants to return the money when the customer ask for it. So keeping that much money in bank is very important. So when they take the portion of deposit for making reserve then there is a question that how the depositers repayed if they came together. So this is known as perception of risk. So using this method will depends on this. Along with this simple money multiplier is not accurate and it is not much realsitic in practical aspect. These are the problems related with simple deposit multiplier

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