Monetary multiplier = 1/rrr where m=maximum amount of new checkable deposits that can be created by given the value of r. r= the percentage of checkable deposits that must be that must be available at all times by the bank. The reserve ratio equals the commercial bank's required reserves divided by the commercials banks checkable deposits liabilities. If bank A had 500.00 in checkable-deposits and the reserve ratio was 10% then it would have to keep 50,000 in reserve.
The monetary multiplier relies on the reserve ratio to create new money. If bank A received $1000 in checkable deposits and the rrr=.2 then they would place $200 in reserves creating $800 dollars of excess money that they can then lend out. That $800 would then end up in bank B. bank B would place 20% of that in the reserve, leaving them with $640 in excess reserve. This would continue until there was no more money for the banks to hold, but in this process the initial $800 excess from bank A would create, a total of $4,000 in new money. Using this we can create an equation for finding the multiplier. The reciprocal of the reserve ratio or 1/R is going to equal the multiplier. In our example given that r=.2 then the monetary multiplier would equal 1/.2 or 5. With 5 as the known multiplier we can the put that into an equation to see how much new money will be created. By taking the initial excess reserve of bank A ($800) and inserting it into the equation D=E x M, where D equals the new amount of checkable deposits, E= excess reserve from bank A and m= equals the multiplier. .
D=E x m .
D= $800 x 5.
D= $4000.
With the multiplier of 5 the $800 in excess from bank A has turned into $4000 of new money.
The monetary multiplier is controlled by the Reserve Requirement Ratio, the higher the ratio the less amount of new money that will be created. For example if the economy went into inflation caused by overspending, the Federal Reserve could raise the rrr to .
