Money Multiplier

Economy

Quick Definition

Money Multiplier is the concept that shows how an initial deposit in the banking system can lead to a larger increase in total money supply.

Detailed Explanation

Money Multiplier explains how banks create money through lending under the fractional reserve system. When a bank receives a deposit, it keeps a portion as reserves and lends the rest. The loaned amount gets deposited again in the banking system, leading to multiple rounds of money creation.

In India, this process is influenced by policies of the Reserve Bank of India.

Formula

👉 Money Multiplier = 1 ÷ Reserve Ratio

Where:

  • Reserve Ratio (RR): Portion of deposits banks must keep as reserves

How It Works

  1. Bank receives deposit
  2. Keeps a fraction as reserve
  3. Lends remaining amount
  4. Loan becomes deposit in another bank
  5. Process repeats → increases money supply

Why Money Multiplier Matters

  • Explains money supply expansion
  • Helps central banks control liquidity
  • Impacts inflation and economic growth

Interpretation

  • Higher Reserve Ratio: Lower money multiplier
  • Lower Reserve Ratio: Higher money multiplier

Example

"<p>If reserve ratio = 10% (0.1):<br /> 👉 Money Multiplier = 1 ÷ 0.1 = 10<br /> 👉 ₹1,000 deposit can create up to ₹10,000 money supply</p>"

← Back to Financial Dictionary