hi guys, hoping for assistance on the money multiplier. I understand what happens if the Fed adds money to the system ie buys treasuries, you multiply the amount bought by the money multiplier to work out the total amount of money added to the economy. My question is: does this logic work in reverse? Ie what happens if the Fed SELLS treasuries (drains money from the system)? Does it only drain the actual amount bought, or do you also multiply this by the money multiplier to work out the total impact? Thanks very much!
Now, this is what my understanding is… take it with a grain of salt… If you (the Fed) give someone (the bank) $10, he coverts it to $25 (the money gets multiplied) If you take away $10 from him, you have effectively taken away $25 that would have been created due to the money multiplying effect… So I would expect it to work in either case… Or one could reason it out by saying that if the bank reserve decreases by $100K, the loan given out will decrease not only by $100K but even more because the bank has to decrease the loans to maintain the desired reserve ratio… and hence the effect will continue…
money multiplier works when the Feld sells treasuries (decreases money supply) as well as when it buys treasuries (increases money supply).
thanks very much!