Question

How would each of the following alter the money multiplier (m)? What will this do to the money supply? a. An increase in loan default risk b. Lower interest rates c. A lower level of development of the financial system d. An increased risk of financial system collapse

Answer 1

a. An increase in loan default risk

Money Multiplier = Money Supply / Monetary Base

If loan default risk rises, banks are reluctant to lend out more money. Thus money supply falls and so the money multiplier as well.

b. Lower interest rates

Lower interest rate induces more demand , so the supply also rises. Rise in money supply will cause rise in value of multiplier. or money multiplier rises.

c. A lower level of development of the financial system

Lower level of development of financial system who cause fall in demand and supply of money. Market asymmetric would hinder the lending and borrowing so the multiplier value will fall.

d. An increased risk of financial system collapse

it will severely affect the monetary system in country. Bank would become more cautious about lending, so the money multiplier will fall.