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

1. Money Multiplier
BY : NEERAJ GARWAL

3. 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.

4. 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.

5. 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)

6. 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.

7. 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!

8. 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.

9. 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.

10. 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%.

11. 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.

12. 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.

13. Money Multiplier Process

14. 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.

15. 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)

16. 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

17. from Apr-2008 to 9-April -10.

19. 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

20. 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

21. 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:

22. 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