What does the money multiplier represent?

The money multiplier is a crucial concept in macroeconomics that illustrates the relationship between the monetary base and the overall money supply in the economy. Specifically, it represents how much the money supply expands with each dollar of monetary base created by the central bank. When banks receive deposits, they are able to loan out a portion of those deposits while keeping a fraction as reserves. This process of re-lending allows for the creation of additional money in the economy, as new loans lead to new deposits, further amplifying the initial increase in the monetary base.

The ratio of the money supply to the monetary base effectively encapsulates this process, indicating how many times the initial money can be multiplied through the banking system. The higher the money multiplier, the more significant the expansion of the money supply relative to the base money provided by the central bank. This concept is foundational for understanding how monetary policy can influence economic activity, as central banks can adjust reserve requirements and interest rates to influence the money supply through the multiplier effect.