# Economics Part A

## Deposit Multiplier

The deposit multiplier is a number that determines the amount of demand deposits that the bank can handle for each \$1 deposited in the vault. If the deposit multiplier is 4, than the bank can hold \$4 in bank account deposits for each \$1 in the vault.

The Relationship between the Reserve Ratio and the Deposit Multiplier

These are both reciprocals of each other. As can be seen in the previous tables:

• The deposit multiplier for bank A is 2 and the reserve ratio is 1/2 (0.5).

• The deposit multiplier for bank B is 5 and the reserve ratio is 1/5 (0.2).

## The Loan Multiplier

The loan multiplier determines the amount that a bank can lend for each \$1 in its vault. If the loan multiplier is 3, that means that the bank can lend \$3 for each \$1 that is in its vault. If the bank has cash of \$2,000, the bank can make loans of up to \$6,000.

### The Relationship between the Loan Multiplier and the Deposit Multiplier (or the Reserve Ratio)

The connection will be demonstrated with an example in which the deposit multiplier in Bank A is 4 (or reserve ratio is 0.25). In this example, the balance sheet of Bank A looks is as follows (small numbers are used for the sake of simplicity).

 Assets Liabilities Cash                                       \$1 Deposits                                \$4 Loans                                     \$3 Equity Capital                       \$0 Total                                      \$4 Total                                      \$4

It can be seen that the loan multiplier is 3 (1 less than the deposit multiplier). Explanation: In order to obtain deposits of \$4, the bank must lend \$3.

If the deposit multiplier for Bank A were 10, its balance sheet would be as follows:

 Assets Liabilities Cash                                       \$1 Deposits                                \$10 Loans                                     \$9 Equity Capital                       \$0 Total                                      \$10 Total                                      \$10

The Reserve Ratio and its Impact on the Level of Risk

For example, a 0.1 reserve ratio means that if all the depositors want to withdraw their money simultaneously, they can receive only 10% (1/10) of it (the reserve ratio). For each \$1 in the bank vault, they deposited \$10.

The lower the reserve ratio (or the higher the deposit multiplier) the higher the risk.

Deposit Multiplier and Loan Multiplier 532