How to Calculate the Multiplier in Economics
The term multiplier, in economics, does not refer to a single, specific concept. It is used in many contexts to theoretically predict what effect a specific input will have on various outputs. For example, economists argue over what effect a dollar of government spending will have on job creation, especially when compared with the same dollar's being spent privately. This has a huge impact on what tax and spending policy should be and can be very subjective. Perhaps the only multiplier that is an objective mathematical ratio that all economists agree on has to do with the money supply and how much bank lending policies can increase it.
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Instructions
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Determine the current reserve standards of banks and other lending institutions you are studying. You can do this by checking with the Federal Register on the current reserve standards or by contacting your U.S. representative's office. Every lending institution is required to keep a certain amount of its deposits on hand as reserve. The rest can be lent out. Thus, if banks have a 10 percent reserve requirement, they must keep $10 of every $100 deposited on hand as cash reserve and may lend out the remaining $90.
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Determine the total amount of cash deposits of the institutions you are surveying. You may get this from investor statements or public documents such as state or federally required filings. You may also ask the banks or credit union boards. They are usually willing to disclose the amount of their deposits.
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Divide the total of deposits by the reserve percentage. In our example of a $100 deposit with a 10 percent reserve, the resulting calculation would be $100 divided by 0.10, which equals $1,000. The way the effect works is that each time money is lent out, it is redeposited in an institution, which is subject to the same reserve requirements. This constant recirculation naturally increases the money supply and reflects real wealth created by those deposits. Thus, the multiplier effect shows that, when $90 of the initial $100 deposit is lent out, a total of $1,000 in deposits is created along the entire chain.
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Tips & Warnings
The constant cycle of deposits and lending is crucial to the growth of any economy. Ideally, it should match real increases in goods and services, which is the actual measure of wealth in a nation's economy. You will note that higher reserve rates produce smaller multiplications, while lower reserve rates produce higher multiplications.
Although it would seem ideal to set very low reserve rates, producing the biggest multiplier effects, there is danger that a very low rate gives only the illusion of wealth creation, while creating risky paper increases that are more likely to crash. The sub-prime mortgage crisis involved extremely low reserve rates. Higher reserve rates reduce the risk of default but, if they are too high, will not sufficiently stimulate economic growth. This is why economists often argue about what the multiplier should be, but not on how it is calculated when applied to deposits and reserves.
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