Money Multiplier

The money multiplier describes how much the total money supply can grow from an initial increase in the monetary base, such as when a central bank adds new money to the economy. When banks receive extra deposits, they typically keep only a fraction in reserve and lend the rest out. Each time money is deposited and re-loaned, it creates new deposits elsewhere, expanding the money supply beyond the original injection.

The size of the money multiplier depends on the reserve ratio—the portion of deposits banks are required to hold and not lend out. A lower reserve ratio leads to a higher money multiplier because more money is available for lending. In practice, the actual increase in money supply may fall short of the theoretical maximum, since banks might not lend all they are able, and some funds might not get redeposited. The money multiplier is mathematically equal to one divided by the reserve ratio.