The Money Supply I

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.