Whythe money multiplier in the United States smaller than the inverse ofthe required reserve ratio
Themoney multiplier refers to the correlation amid the monetary base andthe money supply of a given economy. It is obtained by dividing theincrease in the money supply by increase in the financial base thatled to it. The required reserve ratio refers to the amount of moneyfrom deposits that commercial banks are supposed to keep in reservesand should not be loaned out (Tucker,2016). The required reserve ratio is used by the central bank of acountry to control the amount of money in circulation. In case thereis a lot of money in the economy, the required reserve ratio isincreased, but when there is a shortage of money, the reserve ratiois decreased.
Themoney multiplier can be lower than the required reserve ratio due todifferent reasons. In case there is a currency drain ratio, that is,the number of banknotes that individuals keep in cash instead ofkeeping them in the form of deposits with the commercial banks(Tucker,2016). If citizens in a country have a tendency of storing money intheir homes, then banks will lack money to lend out which makes themoney multiplier to be lower than the required reserve ratio (Tucker,2016). However, if people deposit their banknotes with the commercialbanks, there will be enough money to lend out making the moneymultiplier to be greater than the inverse of the required reserveratio. Another reason why the money multiplier might be higher thanthe required reserve ratio is due to the safety reserve ratio.Commercial banks may opt to keep a reserve ratio that is above therequired reserve ratio making it to exceed the money multiplier.Also, the required reserve ratio might be higher than the moneymultiplier due to the unwillingness of people to borrow money fromthe banks, especially if there is an economic recession. This willmake banks have more money in their reserves. In the United States,the money multiplier is smaller than the inverse of the requiredreserve ratio because people prefer to keep banknotes in the form ofcash instead of keeping the money in banks.
Whydepositing cash into a checking account does not change the moneysupply
Theamount of money deposited in checking account does not alter themoney supply because of the double-entry bookkeeping process. Beforethis money is deposited in the bank, it is in the hands of thepublic. After depositing the money in the checking account, cash isusually debited while the banker’s deposit is credited. Therefore,no change will occur in the money supply. This deposit will furtherbe lent out by the banks to the borrowers. Therefore, the money thatwas deposited in the checking account will be equal to the amount ofmoney in which the cash assets decline. Hence, that is why there isno change in the money supply.
Whythe money supply does not change when one individual writes a checkto another
Moneythat is in the bank is not calculated as a part of the money supply.When a person writes a check to someone else, the money is usuallytransferred from one deposit account to another. Since this moneydoes not go directly into circulation, the supply of money isunlikely to be affected by the transactions (Tucker,2016). Money supply could have been affected in case the cash waswithdrawn from the bank and be injected into the economy through cashwhich could have been used to buy goods or pay for services. Throughsuch an injection, the amount money in circulation would haveincreased.
Accordingto Keynesian, salaries and prices are inflexible mainly downwards.The Keynesian theory argues that the inflexibility of wages issignificant in the short-run since it helps in containingunemployment in the economy. According to the Keynesian theory, ifsalaries were readily flexible both upwards and downwards, then itwould have been difficult to control unemployment (Tucker,2016).For example, if salaries increased, then employers would be forced toemploy a few people a move that would increase the unemployment ratein the economy. Therefore, it is evident that according to theKeynesian theory, inflexibility of prices and wages helps inmaintaining full employment in the economy in the short-run. However,in the long-run, the flexibility of wages and prices tend to favorthe classical economic view. The classical economists do not hold theargument that a decrease in the aggregate demand increases theunemployment rate. However, they argue that flexibility in salariesand prices allows for full employment in the economy. The Keynesiantheory argues that an increase in wages will lead to an increase inaggregate demand in the economy, thus growing the Gross DomesticProduct (GDP). When wages increase, employees will have moredisposable income to consume which would result in an increasedaggregate demand (Tucker,2016).When the GDP of a country grows, more jobs will be created.Therefore, according to the Classical Economists, flexibility inwages and prices assists in maintaining full employment in theeconomy.
Ingraph A, the equilibrium price is P1,andthe equilibrium output is Y1.During an economic recession, the price levels are often high whilethe demand for goods in the economy is usually low. For example, ingraph A, prices are initially at Po,but as the economy moves to full employment, the prices drop to P1.The same case happens to the output. During the downturn of theeconomy, the AD is at Yo,butas the economy improves, AD moves to point Y1.During the depression, consumption was at the point a, but when theeconomy improved the usage of goods shifted to point b. Also, duringan economic slump, the AS is perfectly inelastic in the long-run.However, as the economy improves AS becomes more elastic, and itmoves from the left to the right.
Ingraph B, the equilibrium demand for money is at point c at aninterest rate of ro.During an economic recession, the interest rate on money is oftenhigh, but as the economy moves to the full employment, it decreasesto point r1.However, the demand for money is perfectly inelastic.
Ingraph C, investments increase as the economy moves from a recessionto the full employment. During the economic downturn, the equilibriuminvestment is at point e, but as the economy improves, investmentsshifts to point f.
Tucker,I. B. (2016). for today.London: Cengage Learning.