Deposit Multiplier

Published Apr 9, 2023

Definition of Deposit Multiplier

The deposit multiplier is the amount by which the initial deposit into a bank is multiplied by the banking system to create the total money supply. It measures the effect of a change in bank reserves on the overall money supply in the economy. In other words, it is the number by which the money supply is magnified when new deposits are made in a bank in a fractional reserve banking system.

The deposit multiplier differs from the money multiplier in that the latter describes the change in the economy’s money supply that can be created by a loan.

Example

To illustrate the concept of the Deposit Multiplier, suppose that a bank has USD 100,000 of reserves and a reserve ratio of 10%. This means it is required to hold 10% of its deposits in reserve and can lend out the remaining 90%.
Thus, the initial USD 100,000 deposit can be used to create new loans worth up to USD 900,000, creating a total money supply of USD 1,000,000 (i.e., $100,000 / 0.10).

If these new loans are spent or invested, they will create more deposits in the banking system. Some portion of these new deposits can then be used to create even more loans, and the cycle continues. Therefore, the deposit multiplier also helps to explain how changes in bank reserves can affect the overall money supply in the economy.

Why Deposit Multiplier Matters

The deposit multiplier is a fundamental concept in macroeconomics that helps to explain how changes in bank reserves and monetary policy can affect the broader economy. By understanding this multiplier, policymakers can better anticipate and control the overall money supply, which can have significant implications for inflation, economic growth, and financial stability.

Similarly, understanding the deposit multiplier can help individuals and businesses better understand the impact of their spending and investment decisions on the overall economy.