Answer to Question #104520 in Macroeconomics for annie

Question

If people do not hold cash money multiplier will be equal to 1. True or False explain.

Answer 1

False

Money Multiplier is a term used in economics to refer to how initial deposit by an entity or an individual can lead to a larger final increase in total money supply in the economy. The formula to calculate money multiplier is;

Money Multiplier= Change in total money supply/ Change in monetary base(reserves).

If people do not hold cash, it means that they have invested the cash. The cash invested by the individuals would lead to increase in both deposits and money supply in the economy. Each dollar deposit/bank reserves will result in an increase in the supply of money by several dollars. This will then make money multiplier to be definitely greater than 1.

Therefore, the above statement is false. Money multiplier can only be equal to 1 in a situation where there is 100% reserve banking. In such a situation, the deposits are equal to reserves and thus, an extra dollar of the bank reserves would also increase the deposits by an extra dollar making money multiplier to be equal to 1.