What does the money multiplier indicate?

The money multiplier indicates the maximum amount of money that can be created in the economy for each unit of bank reserves held. It is a key concept in understanding how banks can expand the money supply through the process of fractional reserve banking. When banks receive deposits, they are required to keep only a fraction of those deposits in reserve. The rest can be loaned out, which goes on to create new deposits in the banking system. This cycle repeats, leading to a multiplied effect on the total money supply based on the initial reserves. The formula for the money multiplier is typically expressed as 1 divided by the reserve requirement ratio.

This concept highlights the potential for banks to influence the overall money supply in the economy, which is crucial for macroeconomic management and policy-making. It emphasizes the role of the banking system in facilitating credit and liquidity, ultimately impacting economic activity.