5.9: The Money Supply I

The money multiplier model shows the link between the monetary base and the money supply. In this model, the public chooses to hold money either as currency or as deposits. Currency, denoted by C, is the cash people keep with them, while deposits, shown as D, are the funds kept in bank accounts. The currency–deposit ratio, cr, is the amount of currency held by the public divided by the amount of deposits kept in banks. The currency–deposit ratio shows how much people prefer to hold in cash compared to deposits.

When people deposit their funds in banks, the banks keep a part of those deposits as reserves and lend out the rest. Reserves are denoted by R. The reserve–deposit ratio, rr, is the amount of reserves held by banks divided by the amount of deposits. This ratio is influenced by central bank regulations and bank policies.

The monetary base, denoted by B, consists of the currency held by the public, C, and the reserves held by banks, R. The central bank controls this base through its policies.

The model highlights that the money supply is shaped by three main factors: the size of the monetary base, the currency–deposit ratio, and the reserve–deposit ratio. Together, these determine how the initial stock of money set by the central bank expands into the total money supply in the economy.

The money multiplier model examines the relationship between the monetary base and the money supply.

In this model, the public holds its money in two forms: currency and deposits.

Currency, or C, refers to the cash they keep on hand, and Deposits, or D, are the funds kept in bank accounts.

The currency–deposit ratio, or cr, shows the public's preference for holding money as cash versus deposits. The more trust people have in the security of banks, the more money they will deposit with the bank.

Now, banks receive deposits from the public. They hold a portion as reserves, called R, and lend out the rest.

The reserve–deposit ratio, or rr, represents how much of the deposits banks hold as reserves. Central bank regulations and bank policies influence it. If banks feel cautious, they may hold more cash in reserves than the Central bank requires.

The monetary base, or B, is the total stock of money controlled by the central bank. It includes currency held by the public, C, and reserves held by banks, R.

The model links the money supply to the monetary base, the currency–deposit ratio, and the reserve–deposit ratio.