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Question
How money multiplier is related to Legal Reserve Ratio?
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Solution
- The relationship between the Money Multiplier and the Legal Reserve Ratio (LRR) can be expressed through the following formula:
Money Multiplier = `1/"LRR"` - The money multiplier is inversely related to the LRR. A greater LRR requires banks to maintain higher percentages of deposits as reserves, reducing their ability to lend and thus reducing the money multiplier. Conversely, a lower LRR allows banks to lend out more deposits, resulting in a bigger money multiplier.
For example, if the LRR is 10% (0.1), the money multiplier would be:
Money Multiplier = `1/0.1 = 10`
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