Question

State the formula to compute Credit Multiplier.

Hint:

The credit multiplier is calculated as the inverse of the reserve requirement ratio, determining the total credit creation in the banking system.

Answer 1

The Credit Multiplier is the ratio of the total amount of credit created in the economy to the initial deposit. It is given by the formula: \[ \text{Credit Multiplier} = \frac{1}{\text{Reserve Requirement Ratio}} \] Where the Reserve Requirement Ratio (RRR) is the fraction of deposits that a commercial bank is required to hold as reserves (either in cash or as deposits with the central bank) and cannot lend out. The higher the reserve requirement ratio, the lower the credit multiplier, as banks can lend out less of their deposits.