Economics: Money Multiplier & Currency holdings
The relationship between the various monetary aggregates and the monetary base is described with the help of money multiplier. It must be stable and predictable. The maximum amount of new demand-deposit money is described by the money multiplier which is created with the help of a single initial dollar of excess reserves. Money multiplier model depends upon the two conditions. The first condition is, when excess reserves are zero and the second condition is, when currency in circulation is zero. The joint behavior of the public, banks and the Fed is reflected by the money multiplier. The one factor that influence or affect the multiplier is the decision of the public regarding their desired holdings of the currency and non-transaction deposits in relation to transaction deposits. The desire of the banks to hold the excess reserves in relation to their deposit liabilities and their liquidity concerns are another factor that affect the multiplier and the authority of the Fed to change the required reserve ratios on the deposits of the banks is the third factor that affects the money multiplier. Larger currency holdings are induced by very low interest rates, which consecutively results in a considerable decline in the money multiplier. (Economic Analysis Series No.162, 2008) The standard money multiplier is adopted in the analysis (Mishkin 2001). It is defined as: m = M/MB
Where m = money multiplier;
M = monetary aggregate;
MB = monetary base.
The monetary aggregate can be signify either narrow money, M1, or broad money, M2, while MB is the reserves of the commercial banks kept with the central bank and currency held with the public. According to the above formula, when the currency held with the public is reduced to zero, the money multiplier will be more and when the holdings with the public is more than zero, it will be less. Thus, if the currency holdings are zero, the money multiplier will be more than in...
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