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 quantifies the total credit generated in an economy relative to the initial deposit. Its calculation is defined by the equation: \[ \text{Credit Multiplier} = \frac{1}{\text{Reserve Requirement Ratio}} \] The Reserve Requirement Ratio (RRR) represents the portion of deposits that commercial banks must retain as reserves, either as physical cash or with the central bank, and are prohibited from lending. A higher reserve requirement ratio directly correlates to a lower credit multiplier, because banks have a reduced capacity to lend from their deposits.