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MONEY MULTIPLIER

PRESENTED BY:

KARAN C 132

SREEJA T 93

LATIKA C 40

YASHRAJ T 108

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The Functions of Money

1. Medium of exchange: It facilitates efficient

trading

2. Unit of account : Breakable into Denominations

3. Store of value: It can be used to make purchasesin the future

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The Banking System

In the past,precious metals (e.g. gold or silver) wereused as a medium of exchange

Later on,paper currency was issued, but only central

banks were allowed to issue paper currency that was

convertible into gold

Abandonment of thegold standard: currencies were

no longer convertible by law into anything valuable

Today almost all currency isfiat money, which is

widely accepted because it is declared by government

to be legal tender

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Money Multiplier Mathematical relationship between the monetary base and

money supply of an economy.

Money supply = money multiplier x monetary base

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Relation between Money Base & Supply

Monetary

Base

Coins, paper

currency

Spending

power in

economy

M0,M1,M2,

M3,M4

MONEY MULTIPLIER

Commercial

banks

reserves withcentral bank

Money

supply

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Cash In Circulation

BANK

Depositors funds

[Mr. A]

BANK

Mr. Bs

securities

Bs

spending

power

New loan

Bank lends it out to

Mr. B

Fractional Reserve

Increase of Cash by a factor that is a multiple of

the initial deposit

Fractional

reserve

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central bank money

(all money created

by the central bank

regardless of its form

(banknotes, coins,

electronic money

through loans to

private banks)

commercial bank

money (money

created in the

banking system

through borrowing

and lending)

sometimes referred

to as checkbookmoney

TERMS

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High Powered MoneyCentral Bank

High powered money

=currency + deposits

- MO

Asset to private sector

Liability to Central

Bank

Monetaryconditions

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Open Market Operations

Central Bank Increases

The amount of

High powered money

purchase of securities

Govt. Guarantees to

Pay a fixed rate

Of interest

Govt. bonds carry less

risk

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The RatiosApproach to

the creation of deposit money

Two ratios are important in the determination of the

level of deposit creation:

Commercial banks reserve ratio

Ratio ofcurrency to deposits held by the public

LetR = cash held in bank reserves

C= cash held by the non-bank public

H= level of high-powered money in the economy

=> then:

(25) C+ R = H

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Banks desired reserve ratio (i.e. reserves as a proportionof deposits, D) of banks is given by r:

(26) R = rD The public hold a fraction c of its bank deposits in cash :

(27) C = cD

Substituting into (25) : cD + rD = H

Solving for D yields :

(28) D = H/(c+r)

ifc=0, and r=0.1, then deposits would be 10 x the cash in theeconomy:

D = H/0.1 D = 10H

as c o, the value of D q: e.g suppose c=0.2, then,

D = H/(0.1+0.1) D = H/(0.2) D = 5H

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An expression for money supply (M) andHcan beobtained by noting that the total supply of money is

the sum of deposits (D) and currency (C). Thus:(29) M= C + D

M= cD + H/(c+r)

M= cH/(c+r) + H/(c+r)

(30) M= H[(c+1)/(c+r)]=> (c+1)/(c+r) is known as the money multiplier

it tells us how much bigger is the money supply (M) withrespect to the cash base of the system (H)

=> Money supply = money multiplier x monetary baseE.g.: In the UK banking system the reserve ratio (r) is 0.005 and

the cash ratio (c) is 0.033

=> the value of the money multiplier is just over 27

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Changing the Money Supply

If the central bank wants to raise money supply, it

can use the following instruments:

a) it can lower the required reserve ratio

b) it can lower its discount rate

a) and b) affect the money multiplier

c) it can engage in open market operations (OMO)

This affects the monetary base (H)

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Thank you!!!!