Page 153 - DECO402_Macro Economics

Macroeconomic Theory

Notes (a) Money Multiplier
M 1C
+
m = = (v)
++
H c r e
(b) Supply of Money= Money Multiplier X High Power Money
C D
m = M = D + D ....(vi)
H C + RR + ER
(c) High Powered Money D D D

M
H = ....(vii)
m
In short, supply of money is influenced by money multiplier.

Self Assessment
Fill in the blanks:
1. Monetary base is the .................... of currency in circulation and cash reserve of the banks.
2. By giving loans, banks want to earn more and more .................

17.2 Expansion of Credit Money or Credit Creation

According to the above mentioned discussion, money supply in an economy depends on circulation
of currency and demand deposits of commercial banks. Due to any increase in these two components,
money supply in the economy increases. Quantity of currency is decided by the central bank which
depends on the government’s nature of spending whereas deposit constituent of money supply is
influenced by commercial banks. Commercial banks influence the money supply in the economy by
credit creation or expanding credit money. Credit expansion capacity of commercial banks depends
on their cash reserve ratio. In the words of Lipsey and Chrystal, “Banks can create money by issuing
more promises to pay (deposits) than they have cash reserve available to pay out”.
In the words of Newlyn, “Credit Creation refers to the power of commercial banks to expand secondary
deposits either through the process of making loans or through investment in securities.”
As per G.N. Halm, “The creation of derivative deposits is identical with what is commonly called
the creation of credit."

Did You Know? Quantity of currency is decided by the Reserve bank.
Before analysing the process of credit creation knowledge of some basic concepts will be useful for
the readers.

17.3 Some Basic Concepts

1. Those deposits of the bank, which the depositor may withdraw anytime by drawing a
cheque, are known as demand deposits. It s also known as ‘Chequing deposits’ or ‘Chequable
deposits’. Its detailed classification is as follows:

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