Glossary term
Money Multiplier: Meaning, Formula and Example
Reviewed and approved by Dr. Anamika ShrivastavaPublished Last updated
The money multiplier is the ratio of the total money supply to high powered money, the currency and bank reserves issued by the central bank. It shows how many rupees of money the banking system creates for each rupee of base money, and equals (1 + cdr) ÷ (cdr + rdr).
In more detail
Banks keep only a fraction of deposits in reserve and lend the rest. Each loan becomes a new deposit somewhere, which is again partly lent, so the total money supply expands to a multiple of the initial reserves. A higher reserve ratio shrinks the multiplier; a lower one enlarges it.
Example
If people hold ₹0.20 in cash for every rupee in deposits (cdr = 0.2) and banks keep 10% of deposits as reserves (rdr = 0.1), the multiplier is 1.2 ÷ 0.3 = 4. High powered money of ₹3,000 crore then supports a money supply of ₹12,000 crore.
Key points
- A higher CRR or SLR raises rdr and lowers the multiplier.
- More cash holding by the public (higher cdr) lowers it.
- It is always greater than 1 because rdr is less than 1.
Common mistake
Assuming banks create money without limit. The reserve requirement caps the expansion.
Related terms
MultiplierGross domestic product
Where it is explained
Money creation and the multiplier are explained in Class 12 Macroeconomics Chapter 3: Money and Banking.