Why the money multiplier is 2 rather than0.25/1=4 ? Please explain it Many thank

Question

Why the money multiplier is 2 rather than0.25/1=4 ?
Please explain it
Many thanks!

urrency held by people is $2,000,000. The r In this economy, what is the value of money multiplier? During the The money supply of an economy is $6,000,000, moreover, c reserve ratio is 0.25. There is no excess reserve. Chinese New Year, people withdraw cash from their bank accounts for giving "red envelops", how would this event affect the money supply? 5. required (A) The money multiplier is 5; money supply decreases. (B) The money multiplier is 2, money supply decreases. (C) The money multiplier is 5; money supply increases.

Explanation / Answer

Yes, The correct ans is B) the money multiplier is 2.

It is so because the thing you are saying is correct that money multiplier is 4 but it is for banks. The banking system could generate 4 time with the reserve ratio of 0.25 not the economy.

The multiplier for banks = 1/ reserve ratio, because bank creates money according to the required ratio but the economy is not only bound to required ratio it has other things also which could multiply the money in the economy.

The money multiplier for an economy is the ratio of money supply and monetary base.

Monetary base is the readily available currency or cash in circulation and the required reserves held by the commercial banks.

Monetary base here is the sum of Currency held by people is i.e., $2,000,000 and required reserves

Required reserves = 0.25 * Checakable deposit (or demand deposit DD)

DD = money supply - currency held by public.

DD = $6,000,000 - $2,000,00 = $4,000,000

Required reserves = 0.25 * $4,000,000 = $1,000,000

Monetary base = $2,000,000 + $1,000,000 = $3,000,000

Money supply is given as $6,000,000

Multiplier = $6,000,000 / $3,000,000 = 2

Money multiplier for economy is 2.

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