The multiplier effect is a term relating to monies introduced into the economy by the Federal Reserve System. This term defines the process by which a base amount of money introduced into the banking system, will have a hold value that continues to increase exponentially.
First, the FED-open-market committee, (the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and a rotation of four of the 11 other district bank presidents) make a decision to buy or sell bonds or else make purchases. As a simple example, say $100.00 is printed and spent through the method of purchase by the FED-open-market committee. The entire $100 is placed in the seller’s bank account and the bank now has $100.00 in new reserves.
If the reserve requirements instruct that 20% be kept, then the bank has the option of lending out the other $80.00. In the first step alone, $100.00 has now amounted to hold the value of $180.00 all together. If the $80.00 goes straight into another bank account then again 20% will need to be saved ($16.00) and again 80% of that amount is now available to loan ($64.00)…and so on and so on. Though the monetary base remains $100.00, as the money moves throughout the system, the supply multiplies.
The multiplier effect proves that any small amount of money printed by the FED has the potential to rapidly increase. It is due to this very effect that strict regulations must be placed upon this process ensuring the most positive results to any changes made in the complex and delicate economic balance.