money multiplier 货币乘数

Topic one: Money multiplier

Money multiplier is the relationship between the monetary base and each monetary aggregate. It refers to the linkage between current deposits at banks, which are liabilities of commercial banks to their customers, and bank reserves, which are assets of the commercial bank and liabilities of the central bank. This linkage is the central bank’s source of control over the money supply. Whenever a bank makes a loan to a customer, it creates a new deposit, and it will need to hold more reserves at the central bank.

Multiplier m=M/B=(1+b)/(b+r) where b: cash holding ratio (C/D cash holding / deposit) and r: reserve ratio (R/D banks’ central bank balances bear to deposits)

According to this model, the money supply is decided by the monetary base (the sum of currency in circulation and commercial bank reserves) and the money multiplier (decided by currency/deposit ratio and the reserve ratio).

Weakness:

1.Leakages: the money multiplier is lower when conversion of bank deposits into

currency acts as a drain on commercial banks’ reserves. Other leakages produce the same effect and help explain the relatively low money multipliers. Leakages occur when money is deposited in non-bank financial institutions which operate with a 100% reserve requirement. Money can also leak abroad, and this reduces the amount of reserves available for the banking system.

2.Variable multiplier: the money multiplier model ignores the interest rates and

behavioral relationships. Therefore, the actual multiplier can fluctuate because of variable economic conditions and expectation.

On banks’ side, they manage their assets and liabilities very carefully, with an eye to the future. Then, they may reject some loan applications as being too risky, or may keep extra reserves as an option for future business. As a result, banks routinely hold excess reserves. The volume of excess reserves is variable, and depends on economic conditions (which affect the risk that loans will go unpaid) and on the likely evolution of interest rates (expected future increases increase the attractiveness of holding reserves now).

On the private sector’s side, the behavior can be variable as well. For example, fears of worsening economic condition, or the expectation of declining interest rates, may limit the amount of new credit that the public wants to borrow. As result, the response of banks to reserve availability is less automatic than implied by the money multiplier formulae. As conditions change, or are expected to change, the actual multiplier can fluctuate.