Factors That Determine the M2 Money Multiplier

The economic reasoning analyzing the effect of changes in the required reserve ratio and the currency ratio on the M2 money multiplier is identical to that used for the M1 multiplier in the chapter. An increase in the required reserve ratio r will decrease the amount of multiple deposit expansion, thus lowering the M2 money multiplier. An increase in c means that depositors have shifted out of checkable deposits into currency, and since currency has no multiple deposit expansion, the overall level of multiple deposit expansion for M2 must also fall, lowering the M2 multiplier. An increase in the excess reserves ratio e means that banks use fewer reserves to support deposits, so deposits and the M2 money multiplier fall.

We thus have the same results we found for the M1 multiplier: The M2 money multiplier and M2 money supply are negatively related to the required reserve ratio r, the currency ratio c, and the excess reserves ratio e.

Response to Changes in t and mm

An increase in either t or mm leads to an increase in the M2 multiplier, because the required reserve ratios on time deposits and money market mutual fund shares are zero and hence are lower than the required reserve ratio on checkable deposits.

Both time deposits and money market mutual fund shares undergo more multiple expansion than checkable deposits. Thus a shift out of checkable deposits into time deposits or money market mutual funds, increasing t or mm, implies that the overall level of multiple expansion will increase, raising the M2 money multiplier.

A decline in t or mm will result in less overall multiple expansion, and the M2 money multiplier will decrease, leading to the following conclusion: The M2 money multiplier and M2 money supply are positively related to both the time deposit ratio t and the money market fund ratio mm.

The response of the M2 money supply to all the depositor and required reserve ratios is summarized in Table 1.

(summary Table 1 Response of the M2 Money Supply to Changes in MB„, DL, r, e, c, t, and mm

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