Question

What is the reserve ratio? What is the relationship between the reserve ratio and the money multiplier?

Answer 1

Reserve ratio is a fixed portion of deposits banks should keep with the central bank as per decided rate by the central bank.

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The money multiplier=1/reserve ratio

that means the money supply increases by the reciprocal of the reserve ratio if the banks and public do not hold any extra cash.

the multiplier shows the effect of the money creation by the banking system from given initial deposits.

ex.

the first deposit with xyz bank is $100 and reserve ratio is 10%

then the bank can lend amount in excess of reserve that is $90, that get deposited in any bank then that bank lend 90% of it and the process goes on which will increase the money supply by multiplier amount.

multiplier=1/0.1=10 means the initial deposits of $100 will increase the money supply by $100*10=$1000.