When a central bank increases bank reserves by $1, the money supply rises by more than $1. The amount of extra money created when the central bank increases bank reserves by $1 is called the money multiplier.
The money multiplier is generally greater than 1 because:
multiple choice 1
in a fractional-reserve banking system, each dollar bill is spent more than once (velocity is larger than 1), thereby increasing the money supply by more than $1.
in a fractional-reserve banking system, each dollar of reserves can support more than one dollar of deposits, thereby increasing the money supply by more than $1.
in a 100 percent reserve banking system, each dollar of reserves supports exactly one hundred dollars of deposits, thereby increasing the money supply by $100.
when a central bank increases bank reserves by $1, deposits are automatically increased by $1 as well, thereby increasing the money supply by $2.
The money multiplier is equal to 1 when:
multiple choice 2
reserves > deposits.
reserves < deposits.
reserves = deposits.
The initial money supply is $1,000, of which $500 is currency held by the public. The desired reserve-deposit ratio is 0.2. Calculate the increase in the money supply associated with increases in bank reserves of $1, $5, and $10. What is the money multiplier in this economy? Assume that individuals do not change their currency holdings.
Instructions: Enter your responses as whole numbers.
Increase in bank reservesIncrease in money supply$ 1$ $ 5$ $ 10$
Money multiplier: .
A general rule for calculating the money multiplier is:
multiple choice 3
1/(desired reserve-deposit ratio).
1/desired reserve.
1/deposit ratio.
1/(deposit ratio-desired reserve).