The money multiplier is defined in various ways.[1] Most simply, it can be defined either as the statistic of "commercial bank money"/"central bank money", based on the actual observed quantities of various empirical measures of money supply,[3] such as M2 (broad money) over M0 (base money), or it can be the theoretical "maximum commercial bank money/central bank money" ratio, defined as the reciprocal of the reserve ratio,
The multiplier in the
first (statistic) sense fluctuates continuously based on changes in commercial
bank money and central bank money (though it is at most the theoretical
multiplier), while the multiplier in the
second(legal) sense depends only on the reserve ratio, and thus does not change
unless the law changes.
For purposes of
monetary policy, what is of most interest is the predicted impact of changes in
central bank money on commercial bank money, and in various models of monetary
creation, the associated multiple (the ratio of these two changes) is called
the money multiplier (associated to that model).
For example, if one
assumes that people hold a constant fraction of deposits as cash, one may add a
"currency drain" variable (currency–deposit ratio), and obtain a
multiplier of In monetary economics, a
money multiplier is one of various closely related ratios of commercial bank
money to central bank money
under a fractional-reserve banking
system. Most often,
it measures the maximum amount of
commercial bank money that can be created by a given unit of central bank
money. That is, in a fractional-reserve banking system, the total amount of
loans that commercial banks are allowed to extend (the commercial bank money
that they can legally create) is a multiple of reserves; this multiple is the reciprocal
of the reserve ratio, and it is an economic multiplier.
If banks lend out close
to the maximum allowed by their reserves, then the inequality becomes an
approximate equality, and commercial bank money is central bank money times the
multiplier. If banks instead lend less than the maximum, accumulating excess
reserves, then commercial bank money will be less than central bank money times
the theoretical multiplier.
As a formula and legal
quantity, the money multiplier is not controversial – it is simply the maximum
that commercial banks are allowed to lend out. However, there are various heterodox
theories concerning the mechanism of money creation in a
fractional-reserve banking system, and the implication for monetary policy.