MacroeconomicsI_working_version (1)

68
Chapter 7
Original Deposit = $1,000
Firstbank Lending = (1 – rr) x $1,000
Secondbank Lending = (1 – rr) 2 x $1,000
Thirdbank Lending = (1 – rr) 3 x $1,000
. .
. .
. .
Total Money Supply = [1 + (1 – rr) + (1 – rr) 2 + (1 – rr) 3 + …1 x $1,000 = (1 / rr) x $1,000
Accordingly, each rise in reserves by $1 generates $ (1 / rr) of created money. In our
example, rr = 0,2, so the original $1,000 generates $5,000 of money 5 .
7.6.2. Simplified Money Multiplier Formula
The relation between an excess reserves and required reserve ratio, rr (or m), described
above, is known as the so-called “money multiplier”. It indicates that an injection of $1of
excess reserves into the banking system can result in creation of $1 / rr (or $1 / m) in new
money. The effect of money multiplier on monetary base (high-powered money) is
depicted in Figure 7.5.
Currency Reserves
High-powered money(H)
Currency
Deposits
Money stock (M)
Change in money supply = (1/m) x Change in excess reserves.
Figure 7.5 Relation between high-powered money and the money stock
5 See Mankiw [8]