Economics
Money Multiplier
The money multiplier is a concept used to measure the potential increase in the money supply through the banking system. It represents the ratio of the amount of money created by banks through lending to the amount of new reserves. By understanding the money multiplier, economists and policymakers can assess the impact of changes in the money supply on the economy.
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9 Key excerpts on "Money Multiplier"
- Gang Yi(Author)
- 2019(Publication Date)
- Routledge(Publisher)
We discuss the multiplier in the next section. Having analyzed the components of the monetary base, let us look at the real balance sheet of the central bank, which is given in Table 5.2 at the end of the chapter. We will leave readers the task to apply the theoretical framework provided above to the real data in Table 5.2. 5.3 The Multiplier The establishment of the central bank and the reserve system provide the foundation for the multiple money creation process. In this section, we focus on the multiplier of the broad money, M2, which is defined as M2=C+D+T (5.4) 58 The Money Supply Process where C equals the currency in circulation, D is the total amount of trans-action deposits, and T is equal to the total amount of time deposits. 2 The multiplier for M2 can be written as K=M2/B (5.5) where B is the monetary base, which can be expressed as (5.6) where R = total reserves held by the depository institutions; r 1 = the required reserve ratio for transaction accounts; r2 =the excess reserve ratio expressed as a proportion of transaction accounts; and r 3 = the required reserve ratio for time deposit. Now we substitute equations (5.4) and (5.6) into equation (5.5) and get (5.7) Dividing both the numerator and the denominator of equation (5.7) by D, we have l+c+t K=~~~~~~ c + ri + r2 + r3t (5.8) where c = C/ D, t = T/ Dare the ratio of currency to transaction deposits and the ratio of time deposits to transaction deposits respectively. It is obvious that K is jointly determined by the central bank ( ri, rs), depository institutions (r2), and the public (c, t). 5.4 Predictability of the Multiplier If the multiplier is constant, then the central bank can control the money supply exactly by manipulating the monetary base. However, the multiplier is usually not a constant; the following factors alter the multi-plier. The central bank controls r 1 , r 3 , the legal reserve requirement for transaction and time deposits.
eBook - PDFEconomic Analysis in Historical Perspective
Butterworths Advanced Economics Texts
- J. Creedy, D.P. O'Brien(Authors)
- 2014(Publication Date)
- Butterworth-Heinemann(Publisher)
Fisher in his Purchasing Power of 1911 expound-ed the deposit multiplier and made explicit allowance also for the cash holdings of individuals 49 . However, the concept of the deposit multiplier is widely associated with the names of Macleod, Phillips and Crick 50 . In fact, Macleod does not (like Joplin) explain the re-deposit and multiplier aspects. He simply assumes that extra deposits will be created. Chester Phillips, in a book published in 1921, explained the mechanics using the summation of a series and providing the (elementary) algebraic basis. He distinguished, as elementary textbooks now do, between reserve loss if a single bank tries to expand its loan and expansion by the banking system as a whole. Joplin had, however, dealt with the case of multiple banks, although leaving the question of reserve loss a little cloudy. Phillips' analysis was extended by Lawrence (1928a,b). Although finding fault with some of the former's assumptions concerning the stability and uniformity of the process, he extended the idea to the point (1928b, p. 368) of arguing that banks could make multiple loans on the basis of borrowing from the central bank, thus making control through Bank Rate ineffective—in that penalty borrowing rates could be more than recouped through multiple loans—if all the banks expanded together. Despite the attention which the work of Phillips and the others has received, it is doubtful whether it added very much to the body of theory already in existence concerning bank lending, although the work of Phillips and Lawrence is remarkable for its use of empirical material. The main line of the argument continued in England after Marshall and became a ruling orthodoxy. Thus Hawtrey, in his Currency and Credit of 1919, viewed the banking system as working with fixed reserve ratios and with control of the level of lending through the high-powered money base.
eBook - PDFEconomics
Theory and Practice
- Patrick J. Welch, Gerry F. Welch(Authors)
- 2016(Publication Date)
- Wiley(Publisher)
On the basis of this $9,000 deposit, Bank C can now make a new loan of $8,100 that eventually will be deposited by someone in Bank D, and on and on. Table 8.2 shows this example through several more rounds, showing how new loans are made with each round. It is extremely important to realize that none of these loans could have been made without the initial increase in excess reserves at Hometown Bank. It is this initial increase in excess reserves that caused other banks to experience an increase in their excess reserves. 5 When the full effect of this initial change in excess reserves is carried through the system, all the new loans can be added together to determine the total amount of money created. When we do this, it is apparent that the change in the money supply is some multiple of the initial change in excess reserves. In Table 8.2, a $100,000 increase in the money supply has resulted from an initial $10,000 increase in excess reserves. In this case, there has been a Money Multiplier of 10. Calculating the Money Multiplier The Money Multiplier is determined by the reserve requirement. In fact, the Money Multiplier is the reciprocal of the reserve requirement. (The reciprocal of a fraction is the fraction “flipped over”: The reciprocal of 1/3 is 3/1 or 3.) A 10 percent (1/10) reserve requirement means a multiplier of 10/1, or 10; a 25 percent (1/4) requirement means a multiplier of 4; and a 15 percent (3/20) requirement yields a multiplier of 20/3, or 6.67. Money Multiplier Multiple by which an initial change in excess reserves in the system can change the money supply. An initial increase in excess reserves in the system causes the money supply to grow by a multiple of the initial excess reserve change.
eBook - PDFEconomic Dynamics with Memory
Fractional Calculus Approach
- Vasily E. Tarasov, Valentina V. Podoskina, Valentina V. Tarasova(Authors)
- 2021(Publication Date)
- De Gruyter(Publisher)
The multipliers show how much the final indicators will change with the change of various economic factors. The concept of an economic multiplier was first proposed by Richard F. Kahn in the 1931 paper “The Relation of Home Investment to Unemployment” [185]. Using the employment multiplier (the Kahn’s multiplier), he proved that government spending on organizing of the public works not only leads to increased employment, but also leads to an increase in consumer demand, and this, in turn, contributes to the growth of production and employment in other sectors of the economy. The increase in ag-gregate expenditure (e. g., government spending for “public works”) can lead to the increase of output and income. In 1936, John Keynes published the book ‘The General Theory of Employment, Interest and Money,” [191, 193, 194, 192], which has led to the Keynesian revolution in economic analysis and the birth of modern macroeconomic theory. In this work, Keynes developed the concept of an economic multiplier and multiplicative effects. He proposed the concepts of investment multiplier, saving and consumption multi-pliers. An investment multiplier (the Keynes multiplier) describes how much the in-come increases with increasing investment per unit. The multiplier of accumulation (or consumption) shows how much the accumulation (consumption) increases with an increase in income per unit. In models with continuous time, the indicators and factors (exogenous and en-dogenous variables, impact and response) are usually described by continuously dif-ferentiable functions of time t . Let us consider a variable Y ( t ) , which depends on ex-ogenous (or endogenous) variable X ( t ) . If this dependence is linear, then the multiplier equation is written in the form Y ( t ) = mX ( t ) + b , (6.1) where m and b are some constants.
eBook - PDFMonetary Economics
Policy and its Theoretical Basis
- Keith Bain, Peter Howells(Authors)
- 2017(Publication Date)
- Red Globe Press(Publisher)
2 The money supply process 2.1 Introduction 2.2 Bank balance sheets 2.3 The base-multiplier approach to money supply determination 2.4 The flow of funds approach 2.5 The two approaches compared 2.6 Summary 32 35 38 46 48 51 'Central banks almost everywhere usually implement their policies through tight control of money market interest rates. Academic monetary econo-mists almost everywhere discuss monetary policy in terms of the monetary stock. These facts say something about either central bankers or academic monetary economists, or both.' W Poole, ‘Interest rates and the conduct of monetary policy: a comment’, Carnegie-Rochester Series on Public Policy, 34 (1991). 2.1 Introduction In the last chapter we saw that we encounter many problems when trying to define money, especially if we are looking for a definition which actually specifies the assets that should be included rather than simply specifying money's func-tions. However, we also saw that if the authorities wish to conduct any sort of monetary policy they have to decide which assets they are going to monitor, even if this involves a degree of arbitrariness and requires the frequent redrawing of boundaries. In practice, most monetary authorities work with three measures of money. These are the monetary base , and some measure of narrow and broad money. For convenience, these are usually identified by numbers. Starting from the narrow-est measure, M0 is sometimes used to denote the monetary base. This consists only of notes and coin outside the central bank plus banks’ deposits held with the central bank. In April 2006, the Bank of England began paying interest on these deposits with the predictable result that this led to a jump in these holdings and a break in the M0 series. For this reason, the M0 series was discontinued. The size of the monetary base can still be seen, however, by looking at a new series, titled ‘notes and coin and bank reserves’.
- Thomas F. Cargill(Author)
- 2017(Publication Date)
- Cambridge University Press(Publisher)
This has proved to be difficult, however. There have been periods when the Federal Reserve and other central banks focused on the money supply, but the instability of the Money Multiplier made it difficult to influ-ence money in a predictable manner, especially over short periods of time. This is not to say the money supply is not tied to base money, but only to emphasize that the relationship is not sufficiently stable to provide a foundation for central bank policy. Third – the M2 multiplier and the quantitative easing policy since 2007: Accord-ing to Figure 12.1 , the M2 multiplier (the large dashed line) trended upward from 1959 to the early 1980s, trended downward to the early 1990s, stabilized and then sharply trended downward starting about 2007. The period since 2007 is remark-able. The Federal Reserve adopted a quantitative easing policy (QEP) in 2008, designed to inject very large amounts of base money into the system to offset the decline in GDP. From 1959 to 2007 the monetary base increased on average by 6.7 percent and the M2 money supply increased 7.0 percent, suggesting a close rela-tionship between changes in base money and money over a long period of time; however, from 2008 to 2015 base money increased 23.0 percent but M2 money increased only 6.5 percent. 276 Chapter 12. Central Banks, Base Money and the Money Supply 0 2 4 6 8 10 12 14 $0.00 $2,000.00 $4,000.00 $6,000.00 $8,000.00 $10,000.00 $12,000.00 $14,000.00 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Mulplier Billions Year MB M2 M2M Figure 12.1. Monetary Base (MB), M2 Money Supply and M2 Money Multiplier (M2M), 1959 to 2015. Source: FRED, Federal Reserve Bank of St. Louis. Base money since 2007 increased primarily because the Federal Reserve pur-chased large amounts of Treasury securities and mortgage-backed bonds.
- Alvaro Cencini(Author)
- 2013(Publication Date)
- Bloomsbury Academic(Publisher)
A mere arithmetic multiplier, is tautological. 18 Shall we then share Haberler's drastic judgement and conclude that Keynes's approach to the multiplier is inadequate and fruitless? We have now to ask, what is gained by this procedure? In reality nothing more than that a new name is given to the multiplier. The multiplier is defined in terms of marginal propensity to consume. Instead of the multi-plier we can always say and for marginal propensity to consume we can always substitute 1 — (1/fc). One and the same thing has got two names. Now, I do not question that sometimes it may serve a useful purpose to have two names for the same thing, but it seems that Mr. Keynes has fallen into the trap of treating such a relationship by definition as a causal or empirical relationship between investment and income and that thereby a large part of what he says about the multiplier and its probable magnitude is vitiated. By assuming something about the marginal propensity to consume he assumes something about the multiplier, but this is no more an explanation of the multiplier than pauvrete is an ex-planation of poverty. 19 If by multiplier we mean a functional relation between in-come expenditure and income earning, such that an initial injection will be followed by a finite chain of induced incomes, it is certainly true that Keynes's definition of the marginal propensity to consume does not support the concept in any decisive way. Yet, this obviously does not imply the falsity of Keynes's point of view. On the contrary, the arithmetical multi-plier seems the only logical way of avoiding a contradiction THE MULTIPLIER ANALYSIS 79 between the necessary equalities I = S, Y = C + /, total supply = total, demand, and the psychological law represented by the marginal propensity to consume. Before reaching any conclusion, let us analyse the last para-graph of this section's initial extract from Keynes.
eBook - PDFFinance Constraints and the Theory of Money
Selected Papers
- S. C. Tsiang, Meir Kohn(Authors)
- 2014(Publication Date)
- Academic Press(Publisher)
To use instead the longer income-propagation period as our unit period would not make any difference to our argument above; for there would still be a one-to-one equivalence between the demand for transaction balances (or the demand for loanable funds) and the expenditures on consumption and investment (the latter taken net in the present case). For the convenience of exposition of the multiplier theory, let us assume that consumption and investment (net) in money terms may be approximated by the two following linear functions, respectively, C, = cY t -X - c'r t + C a (14) /, = ιΎ,_! - i'r t + l a (15) where Y is net money income, r the rate of interest, C a and I a the autonomous elements, and the i-subscripts of the variables indicate the period concerned. Furthermore, we shall assume that the demand for idle balances Mi and the supply of money M may also be expressed as the following linear functions: Mi t = Mi a - â (16) M t = R t + Y R t -X + sr t (17) where Mi a is the autonomous element in the demand for idle money; R, the reserve money created by the central bank (i.e., deposits at the 66 Liquidit y Preferenc e and Loanabl e Fund s Theorie s central bank and currency); and y, the inverse of the normal reserve ratio of commercial banks. The expansion of commercial bank credit following an increase in reserve money is supposed to lag one period behind the increase in reserve money. Given the reserves, the supply of money by commercial banks is supposed to be an increasing function of the current rate of interest. The rate of interest r,, as shown above, may be regarded as determined either by the demand and supply of loanable funds or the demand and supply of money. As the equation of the demand and supply of loanable funds brings out the dynamic process of changes more clearly than the demand and supply of money equation, we shall use the former to determine the rate of interest r t .
- Daniel S. Ahearn(Author)
- 2019(Publication Date)
- Columbia University Press(Publisher)
This is yet another reason suggesting more flexible and effective use by the Federal Reserve of existing instruments. Broadened use of open mar-ket operations in all maturities might influence intermediaries' portfolio operations and their willingness to lend more promptly. lie holds demand deposits, currency, and claims against intermediaries in the proportions l:c:t and expands its holdings of these claims proportionally, the multiplier would be: E = l + c + t ra + C+ (Γι +Γ Λ Γ,)' where E is the combined expansion of financial claims (currency, demand de-posits, and intermediary claims), or alternatively, the combined acquisition of credit instruments by banks and intermediaries; X is excess reserves of com-mercial banks available to support deposit expansion; η is reserve requirement for demand deposits; r t and r, are reserve requirements for intermediary claims (held in central bank deposits and currency and in demand deposits in commer-cial banks respectively). If, for example, c=.25, t= 1.25, ra = .20, r t = .03, and r, = .02, the multiplier will be approximately 5, (2.50 4-.4925), and $100 of commercial bank excess reserves will permit expansion of financial claims and of earning assets of banks and intermediaries combined by about $500, of which $200 will be demand deposits, $50 currency, and $250 intermediary claims. To illustrate the point in the text, if intermediaries are larger in relation to banks and accordingly (following the proportionality assumption) the public adds correspondingly more to its holdings of intermediary claims than to de-posits when total financial claims increase, then a given change in banks' excess reserves will have a greater impact on intermediary claims (and credit) than on deposits. Thus if t rises to 2.00 (as opposed to 1.25 in the foregoing illustra-tion) the multiplier rises to 6.27, (3.25 h-.5180), and $100 of commercial bank excess reserves will permit total credit expansion of $627.
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