Money Multiplier

The money multiplier is a ratio that measures the potential increase in the money supply for a given cash injection. This cash injection is often the result of an increase in the monetary base by a government or central bank. The money supply increases significantly more than the actual amount of the cash injection because banks lend out the majority of their deposits. This money can then be deposited at another bank, leading to additional lending by the bank holding the deposit.

The money multiplier is a function of the proportion of deposits that a bank keeps in reserve, known as their reserve ratio. This ratio measures the maximum possible increase in the money supply, but the money multiplier may be lower in reality since banks may not lend as much as possible, and borrowers may not deposit all their cash. A money multiplier is the inverse of the reserve ratio.