The issue of money under the developed system of a market economy and the banking system is subject to the effect of the money multiplier effect. In this case, situations of increasing the money supply in comparison with its initial issue may arise.
The first time the concept of the multiplier of the monetary system was used by R. Cannes at the beginning of the last century, and later this theory was developed by J. Keynes in his work on the general theory of employment, interest and money.
Principle of animation
To describe the principle of animation, we introduce the terms of the rate of reservation and deposit.
The reserve ratio shows the ratio of reserve volumes to the share of deposits held in commercial banks:
rr = R / D, where
rr is the reservation rate.
D - deposits.
R - reserves.
The deposit rate shows the ratio of cash to deposits:
cr = C / D, where
cr is the deposit rate.
C is cash.
D - deposits.
The money supply multiplier is a coefficient that indicates how many times the amount of money will be reduced or increased when the money supply is reduced or increased by one. The multiplier can change both smaller and larger. If the Bank of Russia plans to increase the amount of money, then it will increase the volume of the monetary base. Several mechanisms exist that contribute to this process. With opposite plans, it is logical to expect a decrease in the volume of money. The money offer multiplier depends on the current reserve and deposit rates. The larger they are, the larger the reserve volumes are kept unused by the main manager of funds - the Bank of Russia. The larger the proportion of cash that the population does not invest in deposits, the lower the value of the multiplier, which is not positive for the country's economy.
Effect of deposit
The rate of deposit is the ratio of cash to cashless. When does an increase occur? It is when the amount of cash in the country increases in relation to non-cash.
The money multiplier is equal to:
m = (cr + 1) / (cr + rr), where rr is the reservation rate and cr is the deposit rate.
The last indicator is present both in the numerator and in the denominator of the calculation formula. It affects the money multiplier as follows. If the value of the deposit rate approaches one, the value of the multiplier will be less dependent on the standard of required reserves. It is theoretically possible that the deposit rate will be more than one, that is, there will be more cash in the country than non-cash funds.
Calculation formula
You can derive the mathematical formula for the money multiplier coefficient from two mathematical expressions in stages:
- Let's look at two formulas rr = R / D and cr = C / D, where C is cash, D is deposits, R is reserves.
- Taking the above two formulas, we obtain the equalities: H = C + R = cr x D + rr x D = (cr + rr) x D and M = C + D = cr x D + D = (cr + 1) x D .
- We divide the first equality into another: M / H = ((cr + 1) x D (cr + 1)) / (cr + rr) x D (cr + rr) = (cr + 1) / (cr + rr).
- We get the equality: M = ((cr + 1) / (cr + rr)) x H, hence: M = mult money x H.
- The money multiplier is mult money = (cr + 1) / (cr + rr). In this formula, mult monetary is the multiplier, rr is the reserve ratio, cr is the deposit rate.
Assuming that cash does not exist, the coefficient will be calculated by the formula mult banking = 1 / rr and called the cash banking multiplier.
The dependence of the multiplier and the mass of money
To regulate the money supply, the multiplier is always used. The main bank regulates the value of the ratio by changing the volume of banks' reserves in the country's main credit institution.
The multiplier of the money supply in some countries with a developed economic system can exceed twice the initial issued amount of money. In the process of regulation by the Bank of Russia of the multiplier (k), the term monetary base appears. Its foundation is based on the concept of cash (M 0) as a liquid means of payment and obligatory deposits of corporate banks in the country's main credit institution.
The monetary base is equal to the sum:
- Cash in cash.
- Money in required reserves and on accounts of commercial credit institutions with the Central Bank of the country.
The monetary base shows how much money the Central Bank of Russia can use. It is calculated by the formula:
Money supply (M 2 ) = Money base * Money multiplier.
The higher the norm for obligatory reservation of funds by commercial banks in the Central Bank, the lower the multiplier coefficient. The money multiplier formula shows its dependence on the required reserves ratio. If the multiplier increases, then there is an increase in the non-cash amount of money compared to cash, since the change in the multiplier always depends on the increase in cash and the balance in correspondent accounts.
Bank animation
Money is issued differently in countries with command and market economies. In the first regime, money is issued based on directives from above. In a market economy, there is a banking system consisting of two levels - in the form of the country's main bank and commercial banks. Here, the issue mechanism is based on the influence of the money multiplier coefficient in the banking system.
Bank animation functions only within the framework of a multi-level system:
- The Bank of Russia runs this system.
- Commercial banks force it to work automatically, regardless of the goals of the leaders of individual banks.
The main tasks of the Central Bank of Russia:
- Stably provide the country's currency.
- Pursue credit and monetary policy.
- Promote control over banks.
The main functions of the Central Bank:
- To issue the national currency.
- Act as a lender to all banks.
- Be the main cashier of all payments.
- Provide control over all credit institutions.
The policy of the country's main credit institution is a set of measures in the field of the monetary system. The main goal of the policy is to create conditions for achieving sustainable growth in production, price stability, a high level of population security and a balance of the country's activity in the foreign market.
In the framework of the policy of the country's main creditor, methods of regulating the monetary sphere are applied: direct and indirect. Direct methods are administrative in the form of various orders of the Bank of Russia. The application of these methods is fast and effective. The controlling function of the Bank of Russia over the price or the maximum amount of placed and issued funds, especially in the context of the financial crisis, fully justifies itself. However, direct methods of influence in the event of a negative impact on their work can cause the export of finances from the country abroad.
Indirect methods of regulating the monetary sphere influence the behavior of business entities using the mechanisms of a market economy. The effect of using indirect management methods of the Bank of Russia is closely related to the stage of development of the economy of our country. In transitional periods of time, both direct and indirect instruments are used with a gradual capture of the first instruments by the second.
The main methods are indirect in numerical advantage. They affect the money market as a whole. The combined methods govern specific types of lending and have a regulatory character from above. For example, a direct restriction on the size of loans issued by banks to consumer needs, and a restriction on the maximum loan limits per borrower.
The economy distinguishes between two types of state monetary policy: expensive money and cheap. This or that policy is being built by combining the basic tools used by the main regulators.
The policy of cheap money is typical for a situation of economic decline and high unemployment. Its purpose is to make loans cheaper and more readily available to increase money supply. This entails an increase in total costs and investment in production. The following measures apply:
- Interest rate reduction, stimulating an increase in loans from the main regulator and expansion of own reserves at commercial institutions.
- The purchase by the main regulator of securities with value, paid for by the increase in reserves of banks.
- Decrease in the standard of volumes of reserves by the main regulator, bringing the required reserves to the required standards.
The theory of expensive money aims to reduce the supply of cash in order to reduce total costs and reduce inflationary rates. It includes the following activities:
- An increase in the discount rate, which limits the borrowing of commercial banks from the main regulator.
- Sale by a central lender of securities issued by the state;
- To reduce excess reserves, increase the required reserve ratio;
- Decrease in the money supply multiplier.
One lending institution cannot multiply funds, since the system of interconnected credit institutions increases or decreases them. In the case of a decrease in the required reserve ratio, the money multiplier is triggered, the free reserve increases for banks, which leads to an inevitable increase in borrowing volume and the inclusion of the multiplication mechanism in the country's credit institutions sector.
Of all the active investments of commercial credit institutions in operational processes, only borrowed investments create new objects for placing funds, that is, they allow the issuing function of banking institutions. The more significant the share of loans in its assets, the more significant is the volume of its activity in issuing money.
Since the banking multiplier is formed on the operations of commercial banks to place and raise money, it is often called the monetary multiplier in the literature on economics and finance. This is a coefficient describing the reduction or increase in reserves in the financial sector. It is formed as a result of the emergence of new cash deposits. They are born at the time of issuing loans to customers of banking institutions from free reserves that arrived from outside the credit institution.
Borrowed resources that have left one commercial bank in the form of loans issued become the property of another banking institution, which, in turn, gives its customers these non-cash funds. A monetary unit issued by one bank creates credit reserves in another bank for its balance sheet.
Credit multiplier
Bank multiplier describes the process of increasing or decreasing money from the position of the subject. He gives an answer to the question of who increases the money.
The credit multiplier provides an answer to the question of who is the engine of increase. The process of expanding the volume of cash can be carried out when lending to any activity. The multiplier in the lending process is the ratio of the process of increasing borrowing by a group of commercial banks that caused a change in lending to the process of increasing assets in reserve. In other words, the multiplier in the credit sector shows the ratio of changes in deposit liabilities of commercial banks caused by the expansion of lending to the initial increase in assets in reserve.
Deposit multiplier
This ratio in the process of raising funds reflects the object of increase, that is, cash on the settlement accounts of credit institutions where deposits are placed that increase in the process of multiplication. The main bank of the country, managing the animation mechanism, expands or reduces the emission plans of credit structures.
In the financial sector, the multiplier is the coefficient of change in total output per monetary unit of growth in total demand. Under the animation of the money supply is understood the process of issuing means of payment by participants of economic activity while increasing the monetary base by one monetary unit of bank money.
The multiplier is a coefficient showing how much money supply will increase or decrease as a result of increasing or decreasing their placement in the money circulation system. The ratio of money supply to the monetary base shows the money multiplier.
The monetary base in the simple sense includes cash in cash and mandatory reserves of banks on borrowed funds in the country's currency in the Bank of Russia.
In a more expanded sense, the monetary base includes:
- Cash money.
- Required Reserves.
- Due to banks on correspondent accounts with the Central Bank of Russia.
- Obligations of credit institutions to repurchase securities of value and bonds of the Bank of Russia.
- Means of creating reserves for operations in foreign currency contributed to the Bank of Russia.
The multiplier coefficient of the monetary system can be represented as:
- Ratios of cash in cash to total deposit volume in the banking system.
- Reserve rates, in accordance with the established standard for bank funds, in the main lending institution of our country.
- Ratios of bank reserve funds to total deposit volume in the banking system.
Reserve Standards
The ability of a commercial bank to create reserves is limited by the function of forming reserves with the action of the established norm mechanism. Their volumes are determined by the reserve ratio, the rules of which are determined by administrative documents of the Central Bank. The Bank of Russia calculates reserve contributions as a percentage of bank deposits. Reserve deductions help the country's banks system to provide liquidity in difficult financial time periods and regulate the mass of money in foreign circulation:
M = 1 / pH,
where M is the money supply, is the required reserves ratio.
In order to calculate the money supply that can be created by one unit of free reserves at a given reserve rate,
calculate the money multiplier:
MM = (M 0 + D) / (M 0 + P), where
MM - a multiplier in a certain period of time.
M 0 - money supply outside the circulation of money in commercial banks.
D - the volume of deposits stored in the accounts of credit institutions.
P - reserves held in correspondent accounts and at the cash desks of commercial banks.
The multiplier can cause inflationary or deflationary processes. A stable, stable financial equilibrium in the money market can change the money multiplier, which has increased or decreased over a certain period of time.
Animation Factors
The size of the monetary multiplier directly depends on the following factors:
- Ratios of reserves established by the norm deposited by commercial credit institutions.
- A decrease or increase in the demand for loans among residents of the country and business owners and an increase in the percentage of borrowing funds at the same moment, usually entailing a decrease in the provision of loans, a decrease in the volume of funds accepted for placement.
- The use by individuals of funds borrowed from banks for cash transactions, which causes the suspension of the animation and reduces its real value.
- The increase in cash receipts to the accounts of private and corporate clients or the sale of assets in the market for transactions between banks, which creates the conditions for increasing the coefficient of bank multiplication.
Summary
The modern financial world is designed so that cash means of payment occupy a small part of the entire money supply. To a greater extent at this stage of economic development, citizens use cashless payments. The bulk of the cash volume is generated by commercial banks through the operating activities of credit institutions (placement of deposits, issuance of loans and borrowings). Immediately understand the effect of the mechanism of increasing or reducing money in the economy for the average layman is not easy.
To summarize and recall the main points described in the article above:
- To change the money supply level, a mechanism is applied in the form of a reserve ratio of the established norm and interest on borrowed funds, which commercial banks are obligated to transfer to a correspondent account with the Bank of Russia.
- The money supply is larger than the amount of the initial issue of cash or the monetary base. The ratio of the money supply to the monetary base shows the value of the money multiplier.
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- The main bank of the country, acting as the main regulator, performs its task of managing the monetary system by expanding or compressing the volume of bank money. The money multiplier demonstrates the process of repeatedly increasing or decreasing money as deposits in commercial banks. This occurs in the process of increasing or decreasing the reserves of banks during the implementation by commercial financial organizations of operations to raise and place funds within the existing system.
- Multiplicative can be either an increase or a decrease in the money supply. Analysts in the financial sector pay most attention to the moments of repeated multiplication of money, because the reliability and stability of the monetary system of our country and the decreasing or increasing inflation rate depend on this.