What is money multiplier? How will you determine its value? What ratios play an important role in the determination of the value of the money multiplier?
Money multiplier is the ratio of the stock of money to the stock of high powered money in an economy
Where, MM is the money multiplier
M represents stock of money
H represents high powered money
The value of money multiplier is always greater than 1.
The value of money multiplier can be derived as follows:
We know that M = C + DD = (1 + cdr) DD
M = Money supply
C = Currency held by people
cdr = Currency deposit ratio
DD = Demand deposits
Let treasury deposits of government be D
We know, High powered money = Currency + Reserve money
Or, H = C + R
= cdr D + rdr D
= D (cdr + rdr) (Taking D common)
So, the ratio of money supply to high powered money becomes
But rdr < 1
The currency deposit ratio (cdr) and the reserve deposit ratio (rdr) play an important role in determining the money multiplier.
The currency deposit ratio (cdr) is the ratio of the money (currency) held by public to that they hold in bank deposits.
The reserve deposit ratio (rdr) is the proportion of the total deposits kept by the commercial banks as reserve.