Money Multiplier

By: IDFC AMC

IDFC AMC

What is Money Multiplier?
 

  • RBI creates money in banks via reserve money (M0). As mandated by RBI,
    banks keeps aside some money as part of reserve requirement (CRR1) and lends out
    the excess reserves (excess money in form of deposits in banks).
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  • Money multiplier is the process through which banks create more money
    through its excess reserves, thereby expanding money supply.
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  • In other words, its process of creating more money by banks from reserve
    money.
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  • Chart below shows how banks create more money through excess reserves.
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How Money Multiplier impacts Money Supply?
 

  • Money supply2 is a function of money multiplier and reserve money.
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  • Changes in money multiplier will have impact on the money supply.
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  • Factors determining money multiplier are reserve ratio, currency to deposit ratio, credit deposit ratio.
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  • Low reserve ratio, would require banks to keep aside less reserves as CRR, thereby
    increasing its excess reserves to lend out which increases money supply. Higher reserve
    ratio will have reverse effect on money supply.
  • Currency to deposit ratio (currency leakage) tells how much public is holding as cash
    and not re depositing in banks. More cash held by public means lesser deposits thereby
    reducing the amount bank can lend out resulting in lower money supply. Reverse holds
    true when less cash is held by public.
  • Credit-deposit ratio indicates how much banks are lending out rather than keeping with
    themselves. High ratio means banks are lending out more money which in turn would
    increase money supply.
  • Chart below gives a snap shot of the money supply.
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Money Supply

 

Statistics
 

  • Chart below shows Money supply growth as a function of Reserve money growth and
    Money Multiplier
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Reserve Money Growth

 

  • From the above chart, we can see Money supply growth has been supported by
    increase in money multiplier.
  • Post 2008, creation of reserve money has reduced and increase in money supply has
    predominantly let to growth in money supply.
  • Since 2011, RBI has reduced CRR, which has led to money multiplier increase thereby
    increasing money supply.
  • Table below shows data on money supply, reserve money and money multiplier.
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Reserve Money & Money Multiplier

 

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