Money multiplier

A 100 deposit can create 1,000 in loans through the system

The money multiplier concept explains how banks can increase the money supply through lending. The multiplier effect occurs because banks are required to keep only a fraction of deposits as reserves, allowing them to lend out the rest.

Example

If a bank receives a $100 deposit and the reserve ratio is 10%, it must keep $10 as reserves and can lend out $90. The $90 loaned out can then be deposited in another bank, which keeps $9 as reserves and lends out $81, and so on.

Understanding the money multiplier is crucial for grasping how monetary policy influences the economy and the money supply.

Related concepts

Fractional-reserve banking

Banks lend out most of their deposits

History of money

$100 today is worth more than $100 in the future

Quantitative tightening

Central banks use QT to reduce money supply and increase interest rates

Aversion

Losing $100 hurts roughly 2x more than gaining $100 feels good

Keynesian economics

$1 of government spending generates more than $1 of GDP

Quantity theory of money

MV = PY equation

Educational content, not financial advice.

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