Dene money multiplier. Derive the formula of money multiplier.

1.	Dene money multiplier. Derive the formula of money multiplier.
Answer» We dene money multiplier as the ratio of the stock of money to the stock of high powered money in an economy, viz. MIH. Clearly, its value is greater than 1. We need not always go through the round effects in order to compute the value of the money multiplier. By definition, money supply is equal to currency plus deposits. M = CU + DD = (1 + cdr) DD where, cdr = CU/DD. Assume, for simplicity, that treasury deposit of the Government with RBI is zero. High powered money then consists of currency held by the public and reserves of the commercial banks, which include vault cash and banks’ deposits with RBI. Thus H = CU + R = cdr.DD + rdr.DD = (cdr+ rdr)DD Thus the ratio of money supply to high powered money. \(\frac{M}{H} = \frac{1\,+\,cdr}{cdr\,+\,rdr}\) > 1 as rdr < 1 This is precisely the measure of the money multiplier.

Answer»

We dene money multiplier as the ratio of the stock of money to the stock of high powered money in an economy, viz. MIH. Clearly, its value is greater than 1. We need not always go through the round effects in order to compute the value of the money multiplier. By definition, money supply is equal to currency plus deposits.

M = CU + DD = (1 + cdr) DD where, cdr = CU/DD. Assume, for simplicity, that treasury deposit of the Government with RBI is zero. High powered money then consists of currency held by the public and reserves of the commercial banks, which include vault cash and banks’ deposits with RBI. Thus H = CU + R = cdr.DD + rdr.DD = (cdr+ rdr)DD Thus the ratio of money supply to high powered money.

\(\frac{M}{H} = \frac{1\,+\,cdr}{cdr\,+\,rdr}\) > 1 as rdr < 1

This is precisely the measure of the money multiplier.

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