What is the relationship between high powered money and money multiplier?

Answer 1

The monetary base is highly liquid money that consists of coins, paper money (both as bank vault cash and as currency circulating in the public), and commercial banks' reserves with the central bank.

The Fed can control the monetary base much more precisely than it can control

reserves, so it makes sense to model the money supply process by linking the money supply to the monetary base.

The money multiplier links the money supply M to the monetary base MB via

M = m × M B

where

m = money multiplier.

m > 1, so that a $1 increase in M B leads to an increase in M of more than $1. For this reason, the monetary base is often called high-powered money.

m will depend on depositors' decisions about holdings of currency and banks' decisions about holdings of excess reserves.

Precisely m = (1 + c)/ (r + e + c)

Since, according to our formula,

m = (1 + c)/ (r + e + c)

it appears that the money multiplier m is determined by three factors:

1. The required reserve ratio r.

2. The currency ratio c.

3. The excess reserve ratio e.