Updated Jan 8, 2023 The money multiplier is an economic concept that describes the relationship between the amount of money in circulation and the amount of money banks can lend out. That means it is a measure of how much money banks can create with a given amount of reserves that they have to keep. It can be calculated as the inverse of the reserve requirement (i.e., 1/reserve requirement). Let’s look at a simple example to illustrate this concept. Assume the central bank has created USD 100 and loaned it out to a commercial bank. Now the commercial bank can use this money to make loans to its customers. For the sake of the example, we’ll assume that the reserve requirement is 20%. That means the bank has to keep USD 20 as reserves while it can loan out the remaining USD 80 to its customers. The customers, in turn, can deposit the money in other banks, which can then use USD 64 (i.e., 80*0.8) to make more loans and so on. This process can continue until the original USD 100 has been multiplied by a factor of 5. Or in other words, the money multiplier in this example is 5 (i.e., 1/0.2) The money multiplier is an important concept for central banks and commercial banks alike. For central banks, it is important to understand how much money they can create with a given amount of reserves. For commercial banks, it is important to understand how much money they can lend out with a given amount of reserves. In addition to that, the money multiplier is also critical to understand for policymakers. It helps them to understand how changes in reserve requirements can affect the economy. If the central bank lowers the reserve requirements, the multiplier will increase, leading to more money in circulation and, in turn, more economic activity, and vice versa.Definition of Money Multiplier
Example
Why Money Multiplier Matters
Macroeconomics