Why is the money multiplier in the United States smaller than the inverse of the required reserve ratio?
http://www.economicshelp.org/blog/67/money/money-multiplier-and-reserve-ratio-in-us/
The money multiplier is a key concept in the monetary system. It represents the potential increase in the money supply as a result of a change in the monetary base (such as the central bank's actions) or a change in the required reserve ratio.
The required reserve ratio is the percentage of deposits that banks are required to hold as reserves and not lend out. For example, if the required reserve ratio is set at 10%, banks must hold 10% of their deposits and can lend out the remaining 90%.
The money multiplier is calculated as the reciprocal (inverse) of the required reserve ratio. So if the required reserve ratio is 10%, the money multiplier would be 1/0.1 = 10.
However, in practice, the money multiplier in the United States tends to be smaller than the inverse of the required reserve ratio. There are several reasons for this:
1. Leakages: When banks receive deposits, they don't always lend out the entire amount. Some of the money may be held as excess reserves or used to meet regulatory requirements. These leakages reduce the amount of money that is ultimately created in the economy.
2. Behavior of households and businesses: Even if banks are willing to lend, households and businesses may not be willing to borrow. Economic conditions, consumer sentiment, and business investment decisions all play a role in determining the demand for loans.
3. Central bank actions: The Federal Reserve has the ability to influence the money multiplier through its monetary policy actions. For example, it can increase or decrease the monetary base (the amount of currency in circulation plus bank reserves) through open market operations or changes in interest rates. These actions can impact the lending behavior of banks and the willingness of households and businesses to borrow.
4. Other factors: There are other factors that can affect the money multiplier, such as changes in financial regulations, economic uncertainty, and the global financial environment. All of these variables can influence the lending behavior of banks and the overall money creation process.
In summary, while the money multiplier is theoretically the inverse of the required reserve ratio, in practice, it tends to be smaller in the United States due to leakages, banking behavior, central bank actions, and other factors.