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# Money Multiplier

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Money supply
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# Money Multiplier

About Functioning of Money multiplier; monetary policy tools to control money supply;

About Functioning of Money multiplier; monetary policy tools to control money supply;

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### Money Multiplier

1. 1. Money Multiplier BY : NEERAJ GARWAL
2. 2. MEANING OF MONEY MULTIPLIER The money multiplier is the amount of money that banks generate with each rupee of reserves. Reserves is the amount of deposits that the RBI requires banks to hold and not lend. Banking reserves is the ratio of reserves to the total amount of deposits.
3. 3. Objectives: 1. Determine the maximum potential extent to which the money supply will change following a RBI purchase or sale of government securities. 2. Discuss the ways in which the RBI conducts monetary policy.
4. 4. Money Multiplier  Suppose:  A bank’s reserves are ₹100.  The required reserve ratio is 10%.  How much can that bank’s deposits be?  ₹1000!  Ten times as much as their reserves.  Are we sensing a multiplier?  Money Multiplier = 1/Legal Reserve Ratio(LRR)
5. 5. Money Multiplier Continued  The Money Multiplier tells us: For each rupees the RBI increases reserves by, how much can deposits, and so the money supply, increase If the Required Reserve Ratio is 20% the money multiplier is 5 each rupees the RBI injects into the system can cause deposits to increase by ₹5.
6. 6. Money Multiplier Continued In the real world, the money multiplier is smaller, because: People keep cash in hand! Banks keep excess reserves above zero! The more of either that happens, the smaller the impact of an increase in reserves on the money supply!
7. 7. Monetary Policy Tools  The RBI has folowing tools for conducting monetary policy 1. The Legal Reserve Ratio (LRR)= SLR +CRR Cash Reserve Ratio (CRR): It is a fraction of the reserve money kept in RBI by commercial banks as a ratio of their demand deposits. Statutory Liquidity Ratio (SLR): Reserve requirement that the commercial banks in India require to maintain in the form of gold, government approved securities before providing credit to the customers.
8. 8. Monetary Policy Tools Contd. 2. Rate of Interests:  Bank Rate: Bank rate is the rate charged by the central bank for lending funds to commercial banks.  Rate of Interest: The interest paid to the depositor by Commercial banks  The Repo Rate: when banks need money they approach RBI. The rate at which banks borrow money from the RBI by selling their surplus government securities to RBI is known as "Repo Rate." Repo rate is short form of Repurchase Rate.  The Reverse Repo Rate: Reverse repo rate is the rate of interest offered by RBI, when banks deposit their surplus funds with the RBI for short periods.
9. 9. Monetary Policy Tools Contd. 3. Open Market Operations – Buying and selling bonds and other government securities  Current CRR, SLR, Repo and Reverse Repo Rates: The current rates are (as of last week of December 2015) – CRR is 4 % , SLR is 21.50%, Repo Rate is 8% Reverse Repo Rate is 7%.
10. 10. Money Creation In the model of money creation, loans are first extended by commercial banks – say, ₹1,000 of loans (following the example above), which may then require that the bank borrow ₹100 of reserves either from depositors (or other private sources of financing), or from the central bank.
11. 11. Working Of Money Multiplier  MM is the amount of money the banking system generates with each rupee of reserves. It works like this.  Say you deposit ₹100 with a bank. Banks are required to maintain a percentage of deposits collected as cash reserves with central bank.  The central bank imposes this reserve on the bank to manage liquidity situation in an economy. In India we call this Cash reserve ratio (CRR).  So let us assume CRR is 10%. Then Bank deposits Rs 10 with RBI and lend the ₹ 90 to another customer X.  X takes the loan and say buys a machinery from Y. Y takes the payment and deposits the money in his bank.  The bank again gives the money for credit after netting out the reserves. And the cycle goes on this manner. So ₹100 of deposit with a bank leads to multiplies of the same amount. This is called money multiplier.
12. 12. Money Multiplier Process
13. 13. Measuring Money Multilpier  It can be measured as: M=(1+c)/(c+r), where, c is currency-deposit ratio and r is reserve requirement ratio (CRR+SLR in India’s case).  Currency is currency held by the public for transactions and is given by RBI on a fortnight basis.  Deposits are measured as term deposits at banks and is also given by RBI on a fortnight basis.  Both currency and term deposits form part of the money supply.  We take the ratio of both as people keep part of money as currency and part as deposits. The relation between currency, term deposit and reserve ration gives us the money multiplier. A reduction in r leads to an increase in the money multiplier and vice versa.
14. 14. HIGH POWERED MONEY  It is the total liability of the Monetary authority. It is also called Monetary Base or Money Base. It is denoted with 'H‘.  It consists of: 1) Currency notes and coins in circulation with the public and vault cash of commercial banks (CU) 2) Deposits held by commercial banks and the Government with the RBI (R)
15. 15. MONEY MULTIPLIER  It is the ratio of stock of money to the stock of High powered money. We can calculate Money multiplier by dividing total money supply by High Powered Money.  Value of money multiplier depends on 'cdr' and 'rdr'. So we can calculate Money Multiplier
16. 16. from Apr-2008 to 9-April -10.
17. 17. Supply Of Money The total volume of money in circulation which can be spent by the people at a specific point of time in an economy is called Money Supply. It indicates the total purchasing power in the economy. MEASUREMENT OF MONEY SUPPLY: The Reserve Bank of India has been publishing four different measures of money supply. This system started on 1st April 1977. They are : • M1 =CU + DD (Currency Notes & Coins + Demand Deposits) • M2 = M1 + Savings Deposits with Post Office Savings Bank • M3 = M1 + Net Time Deposits of Commercial Banks • M4 = M3 + Total deposits with post office savings organisations except National Savings Certificates
18. 18. Forms Of Money Narrow Money = M 1, M2 Broad Money = M3, M4 Most Liquid = M1 Least Liquid= M4 Aggregate Monetary Resource= M3 Most Commonly Used Money = M3
19. 19. Implication of monetary policy  The multiplier plays a key role in monetary policy, and the distinction between the multiplier being the maximum amount of commercial bank money created by a given unit of central bank money and approximately equal to the amount created has important implications in monetary policy.  If banks maintain low levels of excess reserves, as they did in the US from 1959 to August 2008, then central banks can finely control broad (commercial bank) money supply by controlling central bank money creation, as the multiplier gives a direct and fixed connection between these.  If, on the other hand, banks accumulate excess reserves, as occurs in some financial crises such as the Great Depression and the Financial crisis of 2007–2010, then this relationship breaks down and central banks can force the broad money supply to shrink, but not force it to grow:
20. 20. Bibliography  https://www.slideshare.net  https://mostlyeconomics.wordpress.com  www.economicsdiscussion.net/money- supply/  Macroeconomics: T.R.Jain & V.K.Ohri  Macroeconomics: Sandeep Garg  All in One : Akansha Sharma  https://www.relakhs.com › Banking