Money Multiplier

Plain definition

The maximum amount by which the money supply can expand from each dollar of new bank reserves; it equals 1 divided by the reserve ratio.

In economics

The money multiplier captures the deposit-expansion process of fractional reserve banking: one dollar of reserves supports multiple rounds of lending and redepositing. With a 10% reserve ratio, the theoretical multiplier is 1/0.10 = 10, so $1,000 in new reserves could support up to$ 10,000 in new deposits.

Example

The central bank injects $1 million in reserves into the banking system with a 10% reserve ratio. Through successive lending and redepositing, the money supply can ultimately rise by up to$ 10 million (the multiplier of 10), assuming banks lend fully and no cash leaks out.

Common confusion

The money multiplier is confused with the spending (fiscal) multiplier. The money multiplier describes bank money creation from reserves; the spending multiplier (1/(1-MPC)) describes how an initial spending injection ripples through incomes. They measure completely different processes.