{"id":352779,"date":"2023-06-22T16:12:48","date_gmt":"2023-06-22T10:42:48","guid":{"rendered":"https:\/\/leverageedu.com\/blog\/?p=352779"},"modified":"2025-10-18T11:41:39","modified_gmt":"2025-10-18T06:11:39","slug":"money-multiplier","status":"publish","type":"post","link":"https:\/\/leverageedu.com\/blog\/money-multiplier\/","title":{"rendered":"What Is Money Multiplier?"},"content":{"rendered":"\n

Last week, Aarav gave his dad \u20b9500 to put in the bank. A few days later, he asked, \u201cIs my money just sitting there doing nothing?\u201d His dad smiled and said, \u201cActually, the bank uses your money to help others and somehow, it creates more<\/em> money too.\u201d<\/p>\n\n\n\n

That got Aarav curious. How can banks turn \u20b9500 into more money without printing anything new?<\/p>\n\n\n\n

The answer is something called the money multiplier. It\u2019s a simple idea from economics that explains how banks help grow the total money in the economy. In this blog, we\u2019ll break it down with examples and easy steps.<\/p>\n\n\n\n\n\n\n

What Is the Concept of Money Multiplier?<\/span><\/h2>\n\n\n\n

Money multiplier is just a way to explain how banks can make more money using the money people put in. When you give your money to the bank, they don\u2019t keep all of it. They keep a small part safe and lend the rest to someone else. That person might spend it or put it in another bank and the same thing happens again.<\/p>\n\n\n\n

So, from your one deposit, more money gets added to the system. That\u2019s called the money multiplier.<\/p>\n\n\n\n

The rule is simple:
Money Multiplier = 1 \u00f7 LRR (Legal Reserve Ratio)
The smaller the LRR, the more money the banks can create.<\/p>\n\n\n\n

Formula of Money Multiplier<\/span><\/h2>\n\n\n\n

The formula for money multiplier is super simple. It goes like this:<\/p>\n\n\n\n

Money Multiplier = 1 \u00f7 LRR<\/strong><\/p>\n\n\n\n

LRR stands for Legal Reserve Ratio, which is just the small part of your money the bank has to keep safe and not lend out.<\/p>\n\n\n\n

So, if the LRR is 0.2 (or 20%), the formula will be:<\/p>\n\n\n\n

Money Multiplier = 1 \u00f7 0.2 = 5<\/strong><\/p>\n\n\n\n

That means \u20b9100 can turn into \u20b9500 in the economy.<\/p>\n\n\n\n

The smaller the LRR, the bigger the multiplier. That\u2019s because banks get to lend more, and that keeps the money cycle going. If the LRR is higher, banks lend less, and the multiplier becomes smaller.<\/p>\n\n\n\n

Sounds Good? Check this out: Economics Project Class 12<\/a><\/strong><\/p>\n\n\n\n

Example of Money Multiplier<\/span><\/h2>\n\n\n\n

Let\u2019s say you deposit \u20b9100 in the bank, and the LRR (Legal Reserve Ratio) is 10% or 0.1. That means the bank keeps \u20b910 and lends out \u20b990.<\/p>\n\n\n\n

Now see what happens step by step:<\/p>\n\n\n\n

Round<\/strong><\/td>Deposits (\u20b9)<\/strong><\/td>Cash Reserve (10%)<\/strong><\/td>Loan Given (\u20b9)<\/strong><\/td><\/tr>
You<\/td>100<\/td>10<\/td>90<\/td><\/tr>
Round 1<\/td>90<\/td>9<\/td>81<\/td><\/tr>
Round 2<\/td>81<\/td>8.1<\/td>72.9<\/td><\/tr>
Round 3<\/td>72.9<\/td>7.29<\/td>65.61<\/td><\/tr>
Round 4<\/td>65.61<\/td>6.56<\/td>59.05<\/td><\/tr>
Round 5<\/td>59.05<\/td>5.91<\/td>53.14<\/td><\/tr>
\u2026<\/td>\u2026<\/td>\u2026<\/td>\u2026<\/td><\/tr>
Total<\/td>\u20b91000<\/td>\u20b9100<\/td>\u20b9900<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

So, your \u20b9100 turns into \u20b91000 in total deposits. That\u2019s how the money multiplier works\u2014it keeps going until no more can be lent.<\/p>\n\n\n\n

What Is the Multiplier Effect?<\/span><\/h2>\n\n\n\n

In economics, the multiplier effect explains how a change in spending (like investment or government money) can lead to a bigger change in total income. <\/p>\n\n\n\n

Think of it as a money chain reaction. When someone spends money, for example, a business invests in new chairs so it doesn\u2019t just stop there. The carpenter earns money, then spends it on groceries, and the grocery shop pays its workers. One small spend? It sets off a cycle that boosts everyone\u2019s income.<\/p>\n\n\n\n

Formula:<\/strong>
Multiplier = Change in Income \u00f7 Change in Spending<\/p>\n\n\n\n

Money Supply Multiplier Effect<\/span><\/h3>\n\n\n\n

This idea also shows up in banking. It\u2019s called the money supply multiplier. When you deposit money in a bank, they don\u2019t just keep it sitting there. A part of it is kept safe (called the reserve), and the rest is lent to someone else. That person spends it, it gets re-deposited, and the cycle continues.<\/p>\n\n\n\n

Banks follow levels like:<\/p>\n\n\n\n