Deposit Multiplier
The Deposit Multiplier is a measure of the amount of money that the banking system can generate with each dollar of reserves. It reflects the total amount of money that can be created in the banking system through the process of deposits and lending. The formula for the deposit multiplier is: Deposit Multiplier=1/Reserve Requirement Ratio.
The reserve requirement ratio is the fraction of deposits that banks are required to hold as reserves and not lend out. A lower reserve requirement ratio means a higher deposit multiplier, allowing banks to create more money through lending. The deposit multiplier is crucial for understanding the money supply and the impact of central bank monetary policies.
Deposit Multiplier
Definition
The deposit multiplier is the multiple of monetary expansion triggered by new deposits in the banking system. It reflects the total amount of money that banks can create through the process of loans and deposits. The formula for calculating the deposit multiplier is: Deposit Multiplier = 1 / Required Reserve Ratio.
Origin
The concept of the deposit multiplier originated in early 20th-century monetary theory research. As the banking system developed, economists gradually recognized the crucial role of banks in the money creation process. Particularly during the Great Depression, the study of the deposit multiplier helped policymakers understand the impact of banking behavior on the money supply.
Categories and Characteristics
The deposit multiplier is mainly divided into two categories: theoretical deposit multiplier and actual deposit multiplier. The theoretical deposit multiplier is the ideal calculated value based on the required reserve ratio, while the actual deposit multiplier takes into account various factors in the bank's actual operations, such as excess reserves and cash leakage.
- Theoretical Deposit Multiplier: The formula is 1 / Required Reserve Ratio, assuming that banks use all available funds for loans.
- Actual Deposit Multiplier: In practice, banks may hold excess reserves or encounter cash leakage, resulting in an actual deposit multiplier lower than the theoretical value.
Specific Cases
Case 1: Suppose the required reserve ratio in a country is 10%, then the theoretical deposit multiplier is 1 / 0.1 = 10. This means that for every unit of new deposit, the banking system can create 10 units of money.
Case 2: In practice, suppose banks hold some excess reserves, resulting in an actual deposit multiplier of 8. This means that for every unit of new deposit, the banking system actually creates 8 units of money.
Common Questions
Question 1: Why is the actual deposit multiplier usually lower than the theoretical deposit multiplier?
Answer: Because in practice, banks may hold excess reserves or encounter cash leakage, resulting in an actual deposit multiplier lower than the theoretical value.
Question 2: How does a change in the required reserve ratio affect the deposit multiplier?
Answer: A lower required reserve ratio increases the deposit multiplier, while a higher required reserve ratio decreases the deposit multiplier.
