The money multiplier equals 1/(1 - R), where R represents the reserve ratio.

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BlackTom AI · Accepted Answer

The question states: The money multiplier equals 1/(1 - R), where R represents the reserve ratio.

Option 1: True. This is not correct in the standard money multiplier framework. In the basic fractional-reserve banking model, the money multiplier is given by 1/R, not 1/(1 - R). The expression 1/(1 - R) would yield values close to 1 when R is small, which does not reflect how deposits, required reserves, and lending interact to create money in the economy. For example, with a reserve ratio R = 0.10, the typical multiplier would be 1/0.10 = 10, whereas 1/(1 - 0.10) = 1/0.90 ≈ 1.11, which is far from the standard result. This demonstrates why this option is incorrect.

Option 2: False. This is the correct characterization in the common teaching of the money multiplier under fractional reserves. The multiplier arises from the repeated process of banks lending out a portion of deposits and other institutions re-depositing those funds, with each round constrained by the reserve ratio. The resulting multiplier is 1/R under the commonly used simplifying assumptions (no currency drain, unlimited deposit creation, etc.). Therefore, stating the multiplier as 1/(1 - R) misstates the relationship and is inaccurate in the standard model.

In short, the incorrect option asserts an incorrect formula for the multiplier, while the correct understanding uses 1/R as the multiplier under typical assumptions, making the statement false.

The money multiplier equals 1/(1 - R), where R represents the reserve ratio.

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