The Money Multiplier Calculating the Money Multiplier 1

The Money Multiplier

Calculating the Money Multiplier = 1 / Reserve Requirement 1 / 0. 10 = 10 Expansion of the Money Supply = Money Multiplier x Excess Reserves 10 x $900 = $9, 000

Required Reserve Ratio Required Reserve Excess Reserve 1% 5% 10% 1, 000 (0. 01) $10 $50 $100 $125 $150 $250 $1, 000 – ($10) $990 $950 $900 $875 $850 $750 100 20 10 8 6. 7 4 Deposit Expansion Multiplier 1/ (0. 01) Maximum increase in the Money Supply 12. 5% 15% 25% $99, 000 $19, 000 $7, 000 $5, 695 $3, 000 $990 (100)

1) If the Federal Reserve System wants to increase the money supply, should it raise or lower the reserve requirement? Why? • Lower the reserve requirement. Banks would be able to make more loans, and the multiplier would increase.

2) If the Federal Reserve System wants to decrease the money supply, should it raise or lower the reserve requirement? Why? • Raise the reserve requirement. Banks would be able to make fewer loans, and the multiplier would decrease.

3) What economic goal might the Federal Reserve try to meet by reducing the money supply? • Reducing Inflation & promote stability.

4) If the Federal Reserve increases the reserve requirement and velocity remains stable, what will happen to the nominal GDP? Why? • Nominal GDP will fall because the money supply fell.

5) Why might the money supply not expand by the amount predicted by the deposit expansion multiplier? • Might not lend out all of excess reserves, borrowers could default on loans, prediction occurs under ideal circumstances.

6) Why don’t we want an infinite growth of the money supply? (Hint: remember the equation of exchange, MV = PQ) • Because we know resources are scarce, the quantity of money cannot be infinite. Therefore an infinite money multiplier (0% required reserve) would cause hyperinflation.