The smaller the required reserve ratio, the larger the simple deposit multiplier.
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If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked. The money multiplier refers to the way an initial deposit can lead to a larger final increase in the total money supply. Let’s say commercial banks gain deposits of $1 million, which leads to a final money supply of $10 million. In this example, the money multiplier is 10. This concept is a key element of the fractional banking system.
The Reserve RatioThe percentage of deposits that banks hold in liquid reserves is the reserve ratio. The Formula for Money MultiplierTheoretically, it’s possible to predict the size of the money multiplier if you know the reserve ratio.
Example of Money Multiplier
Note: Although this example stops at stage 10, the process can theoretically continue for a long time, or until deposits are fractionally very small.
Using the Reserve Ratio to Influence Monetary PolicyIf a Central Bank demands a higher reserve ratio, then it’ll act as a deflationary monetary policy. With a higher reserve ratio comes reduced bank lending and a reduction in the money supply. Money Multiplier in the Real WorldWhen we talk about simple theories of the money multiplier, it’s assumed that if the bank lends $90, all $90 will return. In the real world, though, there are many reasons why the actual money multiplier is quite a bit smaller than the theoretical money multiplier.
Due to these factors, the money multiplier and reserve ratio are purely theoretical. Loan-First MultiplierThe model of the money multiplier suggests that banks first wait for a deposit and then lend out a fraction of it. But in the real world, banks might take it upon themselves to issue out a loan. Then they seek reserves from other financial institutions or private individuals. One example is the credit bubble of 2000 to 2007. During this period, many banks lent mortgages by borrowing on short-term money markets. The money they were lending was not related to savings deposit accounts. Money Multiplier and Quantitative EasingBetween 2009 and 2012, Central Banks pursued quantitative easing, which involves growing the monetary base. They were able to attain greater cash reserves by buying bonds off banks. Theoretically, this increase in the money multiplier should also increase the overall money supply by a large amount. But in practice, this didn’t take place. Since the banks weren’t keen to lend extra money, the money supply didn’t increase. Plus, banks were attempting to improve their reserves after the credit crunch and previous over-extension of loans. What is the relationship between the required reserve ratio and the simple deposit multiplier?The bank's reserve requirement ratio determines how much money is available to loan out and therefore the amount of these created deposits. The deposit multiplier is then the ratio of the amount of the checkable deposits to the reserve amount. The deposit multiplier is the inverse of the reserve requirement ratio.
What happens to the deposit multiplier as the reserve ratio increases?The higher the Fed's reserve requirement, the smaller the deposit multiplier, and the less of an increase in deposits created through lending.
What is the relationship between the required reserve ratio and the simple deposit multiplier money multiplier )? Quizlet?D) The simple deposit multiplier is equal to 1 divided by the required reserve ratio.
What would happen if the required reserve ratio was lowered?When the Federal Reserve decreases the reserve ratio, it lowers the amount of cash that banks are required to hold in reserves, allowing them to make more loans to consumers and businesses. This increases the nation's money supply and expands the economy.
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