Deposit Multiplier

The deposit multiplier (also called the deposit expansion multiplier or simple deposit multiplier) measures the maximum amount of checkable deposits a banking system can create for each unit of reserves held. It arises from fractional reserve banking: banks hold a fraction of deposits as reserves and lend out the remainder, which then becomes deposits at other banks and can be re-lent.

How it works

• Banks are required to hold a portion of deposits as reserves (required reserves) set by the central bank.
• The portion not held in reserve can be lent to borrowers. Borrowed funds that are redeposited become new deposits at other banks, a process that repeats and expands total deposits.
• The deposit multiplier indicates the theoretical maximum expansion of deposits from an initial reserve injection, assuming no cash withdrawals or excess reserves.

Calculation and example

• Formula: Deposit multiplier = 1 / reserve requirement (expressed as a decimal).
• Example: If the reserve requirement is 20% (0.20), the deposit multiplier = 1 / 0.20 = 5.
  That implies $1 of reserves can support up to $5 in total checkable deposits in the banking system, in the theoretical maximum case.

Factors that reduce the theoretical maximum

• Excess reserves: banks may hold reserves above the required minimum, reducing lending.
• Currency leakage: when borrowers or depositors hold cash outside the banking system, less is redeposited.
• Non-checkable deposits and regulatory or operational constraints also limit expansion.
  These realities mean actual deposit expansion is typically smaller than the simple deposit multiplier suggests.

Deposit multiplier vs. money multiplier

• Deposit multiplier refers specifically to the potential expansion of checkable deposits from reserves.
• The money multiplier is a broader concept that reflects the overall change in the money supply (including currency and various deposit types) resulting from bank lending and other behaviors.
• The money multiplier is generally smaller than the theoretical deposit multiplier because of excess reserves, currency holdings, and other frictions.

Policy implications

• Central banks influence the potential scale of deposit creation by changing reserve requirements: higher reserve ratios reduce the deposit multiplier and the potential for deposit expansion; lower ratios increase it.
• Central banks can also affect lending and deposit expansion through interest on reserves, open market operations, and other tools that influence banks’ willingness to hold excess reserves.

Key takeaways

• The deposit multiplier shows the maximum possible expansion of checkable deposits per unit of reserves under fractional reserve banking.
• It is calculated as the inverse of the reserve requirement (1 / reserve ratio).
• Real-world factors—excess reserves, cash withdrawals, and behavioral responses—make actual money creation smaller than the theoretical multiplier.
• The deposit multiplier is related to, but distinct from, the broader money multiplier used to describe changes in the overall money supply.