Money multiplier

The money multiplier is a monetary theoretical model that explains the interaction between the central bank, commercial banks and households in the development of the money supply. The model starts from a multiplication of the output of the central bank central bank money through commercial banks - hence the term name multiplier.

• 2.1 reserve requirements of commercial banks
• 2.2 desire of households by holding cash
• 2.3 Criticism of the model

Model structure

The model works in three steps. Steps 2 and 3 cause interdependence by the multiplier effect.

Step 1: issuing of cash by the central bank

The starting point for consideration is produced by the Central Bank cash. This, she passes through commercial banks to households. It thus represents the first overall money supply dar.

Step 2: deposit of cash by the budget

In a second step, the model assumes that households do not want to keep in the form of cash, at least some of their money, but pay (eg for security reasons or because of hoped- interest) as a demand deposit in a bank account. The amount of assets of households does not change this way - only the composition of assets: A portion of the assets (and therefore also a part of the money supply ) is still out of cash, a part of so-called bank money - the money in a bank account.

Step 3: lending by the commercial banks

To complete the model, the usual operating activities of commercial banks is now also considered. This is usually is to borrow money at a lower interest rate and lend at a higher interest rate. This assumption is taken into account in the model by the fact that the commercial banks to pass on that of their customers paid (cash) money to other customers - for example in the form of an overdraft loan. The money supply now consists of

• The cash of households from step 1
• The book money these households from step 2
• The obtained loans of households from step 3

Since " overlap " the last two elements, the consideration money supply increased.

Multiplier character

Taking place in step 3 lending leads in the model to a partial repetition of step 2 So could a bank customer from his checking account to withdraw money via a line of credit and pay with it, for example, the account of a craftsman. This in turn could deposit the money in his own account and result in a repetition of step 2.

Fundamentally could repeat steps 2 and 3 unlimited and thus lead to an unforeseeable duplication of the money supply.

Limitations of the model and criticism

Reserve requirements of commercial banks

The multiplier character is defined by a simple relationship: their customers' deposits, banks can not pass in its entirety as loans. This is partly due to legal restrictions ( for example, a possible mandatory minimum reserve, which is located in the euro area since October 2008, two percent, and as of January 2012 with a percentage of deposits received ) on the other, to the economic reason of the bank: you must be regular disbursement requests from its clients expect, so they at least have to keep a portion of the paid-up cash as collateral - otherwise they would be in danger of becoming insolvent in the short term. This would lead to the opening of insolvency proceedings and to a loss of reputation of the bank.

Commercial banks can therefore pass on only a portion of the deposits received as loans. The share of deposits issued Not again, " slowed down" from the multiplier effect.

Desire of households by holding cash

A further slowdown experienced by the multiplier effect in that the households only want to keep some of their money in the form of book money - is called economically incomplete substitutes. The portion of the money received, the households do not make the banks available, is removed from the circuit.

Conclusion: For each subsequent run of the model to (a ) reduce the lending of banks and ( b ) the deposits of households. This causes the multiplication process slowly grinds to a halt. Mathematically, this corresponds to a geometric series expansion and the result is the following money multiplier:

M1 this context is the amount of money that results from the multiplier effect, M0, the central bank money, RS the reserve ratio of banks ( ie that portion of deposit that is voluntarily or involuntarily, not loaned out ) and BH the cash holdings of households ( ie the proportion of cash on their entire stock of money ( = cash cash) ).

Criticism of the model

There is a whole series of criticisms of this Keynesian model characterized.

For example, criticizes the classical liberalism that households do not view money as a store of value - money therefore serves only as a means of payment for the purchase of goods. This is the entire character substitution between cash and bank money (and consequently the Muliplikatoreffekt ) in question. The classical theory is instead assumed that economic agents hold some of their assets as means of payment in cash and invest another part in high-yield -making, long- term assets. However, these are by universal consensus on any monetary definition. Therefore, there are purely classical understanding no multiplier effect.

Significance of the model

Even considering the classical and neoclassical criticisms can not be denied a " multiplication " of the central bank money through the book money. In mature economies, which have a well-developed banking system, the book makes money today from well over 90 percent of the various money supply definitions.

The importance of the model lies in the implicit questioning position of the central bank to influence the money supply. In an imaginary reserve ratio of ten percent ( which is far above the usual reserve ratios ) are from 100 euros through the multiplier effect, finally, 1000:

Thus, the central bank can control the money supply, only 1:10 with a lever through its direct monetary policy instruments ( open market operations ). However, modern central banks have ( such as the ECB) today about other effective tools with which they can also influence the amount of virtual currency - for example, the mentioned reserve or the ability to influence short-term interest rates in the financial market. Thus, most economists believe that central banks have sufficient monetary influence in bank- dominated capital markets.

• Monetary policy