The Money Multiplier

The money multiplier is a textbook idea about how lending grows a country's money supply. In its simple form it says the money supply is a multiple of the monetary base, and that the multiple is 1 divided by the reserve ratio. Canada phased out its statutory reserve requirements between 1992 and 1994, so the textbook shortcut has no Canadian required ratio to work with. You can still measure the ratio of money to the monetary base here. It tells you what lending produced, not what lending is allowed to produce.

The idea matters on a site about personal finance for one plain reason: its vocabulary gets borrowed into sales talk. Once you know how money is actually created in Canada, a borrowed version of the story is easy to test.

What is the money multiplier?

The money multiplier is the ratio of a measure of the money supply to the monetary base.

The monetary base is central bank money: bank notes in circulation plus the settlement balances that financial institutions hold at the Bank of Canada. The money supply is larger. It adds the deposits people and businesses hold at lenders, and broader measures add more.

In the textbook, the ratio is fixed by one number, the reserve ratio. That is the share of each deposit a lender keeps as reserves instead of lending. Money held as reserves is not lent. Money that is lent gets spent, lands in someone else's account as a new deposit, and supports a further loan. The chain shrinks at each step until it runs out.

Two different things share the name, and keeping them apart is the key to the whole subject:

• The measured ratio. Take a published measure of money, divide it by the monetary base for the same date, and you have a number. It exists in any country, with or without reserve rules.
• The textbook model. It says the ratio is set by a required reserve ratio and predicts how much lending a new dollar of reserves will cause. That model needs a fixed ratio that Canada no longer has.

How does the textbook model work?

The textbook tells the story in four steps.

1. Someone deposits $100 of new reserves at a lender.
2. The lender keeps a fraction as reserves, set by the reserve ratio, and lends the rest.
3. The borrower spends the loan, and whoever receives the money deposits it at some lender.
4. In the model, the cycle repeats. Each round is smaller, because a fraction is kept back every time.

Here is that chain as an illustrative example, with a 10% reserve ratio and every dollar redeposited. These are hypothetical numbers, not Canadian data.

After five rounds the deposits add up to $409.51. If the chain ran forever, they would approach $1,000, ten times the first $100. That factor of ten is the multiplier. Notice what the model assumes: every lender keeps exactly 10%, every borrower spends, every recipient deposits, and a willing borrower is always waiting. Take away any one of those and the total falls.

How do you calculate the money multiplier?

The simplest formula is 1 divided by the reserve ratio.

The relationship is inverse: the higher the ratio, the smaller the multiplier.

A fuller formula adds the cash people keep in their wallets. Cash held outside accounts is not redeposited, so it leaks out of the chain. Write c for currency divided by deposits and r for reserves divided by deposits. The multiplier becomes (1 + c) divided by (r + c).

Illustrative example: assume r is 10% and c is 25%. The multiplier is 1.25 divided by 0.35, or about 3.57. A $100 increase in the monetary base then supports about $357.14 of money in the model: about $285.71 in deposits and $71.43 in cash. The base is used up as $28.57 of reserves plus $71.43 of cash, which adds back to $100. One assumption about cash cut the multiplier from 10 to under 4.

The formula works the same way in any version. What changes from country to country is whether any law supplies r, and whether the model's chain of steps describes how lending really happens.

Can you measure a money multiplier in Canada today?

Yes. What Canada lacks is a required reserve ratio, not a money supply or a monetary base. Pick a measure of money, divide it by the monetary base for the same date, and you have a measured Canadian ratio.

The Bank of Canada publishes several measures of money, each with its own definition:

• M1+ counts currency held by the public plus chequable deposits at chartered banks, trust and mortgage loan companies, credit unions and caisses populaires.
• M1++ adds non-chequable notice deposits at those institutions.
• M2++ is broader again. It adds items such as Canada Savings Bonds and other retail instruments, and net contributions to mutual funds.

Each measure gives a different ratio from the same base, and a broader measure gives a larger one. So a multiplier figure is only meaningful with three labels: which measure of money, which definition of the base, and which date.

Read that number for what it is. It describes the outcome of past lending, saving and cash use. It does not predict that a new dollar of central bank money will produce a set amount of new lending. That prediction belongs to the textbook model, and the model needs a fixed ratio that Canada removed.

When did Canada end reserve requirements?

Canada phased them out between 1992 and 1994. The Bank of Canada Review of Winter 2005 to 2006, in an article by Michael Bordo and Angela Redish on seventy years of the Bank of Canada, dates the phase-out to those years and describes it as the reduction of the required reserve ratio to zero. The same article notes that by the mid 1990s the old ratio was barely binding anyway, because lenders held plenty of cash to stock their automated teller machines.

So a sentence that says Canada abolished reserve requirements "in 1992" gives only the start date. The accurate version is the range.

How is money created, and lending limited, in Canada today?

Most money in Canada is created when a lender makes a loan. The Library of Parliament says so plainly: the majority of money in the Canadian economy is created within the private system of lenders when they extend new loans, each loan creating a matching deposit in the borrower's account. The deposit did not exist before the loan. This reverses the textbook order, where deposits arrive first and are then lent out.

Here is what a new loan looks like on the two balance sheets involved.

Money also disappears. The Bank of England's 2014 bulletin explains that repaying a loan destroys money, just as taking one out creates it. When households and businesses pay down debt faster than they borrow, the money supply shrinks.

Central bank money is a separate, smaller layer. It is bank notes plus the settlement balances institutions use to pay each other. Every business day, financial institutions move money back and forth for their customers. Those left short at day's end borrow overnight from those with extra. The Bank of Canada sets a target for that overnight rate. Since 23 March 2020 it has run a floor system: it supplies enough settlement balances that overnight lending trades near its deposit rate. As of 30 January 2025 that deposit rate is 5 basis points below the target, and the operating band is 30 basis points wide.

If a reserve ratio does not hold lending back, what does? Several things.

• Capital rules. A lender must hold loss-absorbing capital against what it lends. The Library of Parliament notes that what a lender can create depends on its equity relative to its assets. Who sets the rules depends on the charter. OSFI sets them for federally regulated deposit-taking institutions; its 2027 capital guideline takes effect on 1 November 2026 for institutions with an October 31 year end, and on 1 January 2027 for those with a December 31 year end. In Quebec, the AMF's Capital Adequacy Guideline covers financial services cooperatives, credit unions outside a federation, trust companies, savings companies and other deposit institutions it regulates. A credit union chartered in another province answers to that province.
• Liquidity. A lender must be able to meet withdrawals and payments under strain. A new deposit usually moves to another institution as soon as the borrower spends it, and the lender has to settle that payment.
• Borrowers. A loan needs someone who wants to borrow and who qualifies. No supply of reserves makes an unwilling borrower sign.
• The price of money. The policy rate feeds into what lenders charge and pay. When it rises, some borrowing stops being worth doing; when it falls, more of it becomes worthwhile.

The Bank of Canada can also change quantities when it chooses. During the pandemic it bought assets on a large scale. The Library of Parliament reports that its balance sheet grew from $120 billion on 11 March 2020 to a peak of $575 billion on 10 March 2021. Those purchases added settlement balances, which is central bank money. None of it involved a reserve ratio.

What are the limits of the money multiplier as a model?

The model's own assumptions are where it breaks. Five limits explain why economists who study central banks now treat it as a teaching device.

1. The required ratio may not exist. In Canada it has not since the 1992 to 1994 phase-out, so the model has no legal number to start from.
2. Lenders choose what reserves to hold. Where lenders keep more than any minimum, or where there is no minimum, the chain is shorter than the formula says.
3. The public holds cash. Cash kept outside accounts leaves the chain, which is why the fuller formula gives a smaller multiplier.
4. Loans come first. A lender creates the deposit when it makes the loan, then finds the settlement balances it needs. The Bank of England's 2014 bulletin notes that central banks today typically set the price of reserves, the interest rate, rather than their quantity.
5. Demand decides a great deal. If people and businesses do not want to borrow, or do not qualify, extra reserves produce no lending at all.

None of this makes the model useless. It still shows, in a few lines, that lending adds to the money supply. It also explains why central banks once talked about controlling quantities of money and now talk about setting a rate. It fails only when it is presented as a description of how Canadian lending works today.

Why does so much online material describe a different system?

Most explanations a Canadian finds online describe the United States and its central bank, the Federal Reserve. Many were written when the United States still had reserve requirements. The Federal Reserve cut its reserve requirement ratios to zero effective 26 March 2020, so the textbook mechanism does not operate there either.

Canada's central bank is the Bank of Canada, and its tool is the target for the overnight rate. It adjusts that target to keep inflation on track. When rates fall, people and businesses pay less interest on loans and mortgages and earn less on savings; when rates rise, the reverse happens.

So before you rely on anything about reserve ratios, check two things: which country's system it describes, and whether that description is still current. An article written for another country, or before 1994 in Canada or 2020 in the United States, may be accurate about a system that no longer exists.

What claims borrow this vocabulary, and how can you check them?

The multiplier turns up in financial sales talk in a handful of forms. Each can be checked against the public sources above.

Why does the ten-for-one version survive? It offers a grievance and a remedy in one breath: a system working against you, and a product that answers it. That combination persuades well, which is exactly why it deserves checking.

Three questions sort most claims quickly:

1. Which country, and which year? Canada phased out reserve requirements between 1992 and 1994; the United States cut its ratios to zero in 2020.
2. Which ratio? A required ratio set by law, or a measured ratio of money to the monetary base? The first no longer exists in Canada; the second exists but limits nothing.
3. Does the conclusion follow? Even where a required ratio applied, nothing in it would let a household or a policy create money. If the argument needs that step, it has a gap.

What does this mean for how a household borrows?

Strip the multiplier out and some useful facts remain. When you borrow, somebody lends and somebody is paid the interest. When you spend savings, those savings stop earning. Neither fact needs any claim about money creation.

The table sets out who lends and who is paid for four common ways to fund a purchase. It is a map of who owes whom, not a recommendation.

A specially designed, high-cash-value, participating whole life insurance policy is life insurance first. It exists to pay a death benefit when the person insured dies, and it is not a deposit, a savings account or an investment. It creates no money. What it can build over time is a cash value set out in the contract, with guaranteed values separate from dividends, which are not guaranteed.

If the owner takes a policy loan, the insurer advances the money under the contract. The insurer sets the loan interest rate and may change it, and the interest is owed to and paid to the insurer. It leaves the household just as interest to any other lender does. Unpaid loans and interest reduce the death benefit paid when the person insured dies. If the balance grows past what the policy's value can support, the contract can end. A policy loan is also a disposition for tax purposes; it produces income only to the extent it exceeds the policy's adjusted cost basis, as explained on the page about when a policy loan becomes taxable.

Whether any route costs less than another depends on real numbers: the rates, the fees, the policy's guaranteed and illustrated values, and what you would otherwise have done with the money. The ideas that genuinely help with that choice are covered in money principles without borrowed vocabulary: opportunity cost, capital recovery, and the years it takes to rebuild spent savings. For a worked comparison of routes, see paying for a vehicle. For the arguments against using a policy this way, see objections and risks.

Where can you read the primary sources?

All of these are free, and none of them sells a financial product. That is the reason to start with them rather than with anyone's summary, this one included.

• Bank of Canada, Framework for market operations and liquidity provision. The floor system since 23 March 2020, and the deposit rate and operating band.
• Bank of Canada, Understanding our policy interest rate. The overnight market in plain language, and how the policy rate reaches loans and savings.
• Bank of Canada, Monetary aggregates. The official definitions of M1+, M1++ and M2++.
• Bank of Canada Review, Winter 2005 to 2006, Bordo and Redish. The history of the Bank of Canada, including the 1992 to 1994 phase-out of reserve requirements.
• Library of Parliament, How the Bank of Canada Creates Money Through its Asset Purchases (2015-51-E, 19 May 2021). Loans creating deposits in Canada, and the pandemic asset purchases.
• Bank of England, Money creation in the modern economy (Quarterly Bulletin 2014 Q1). A clear British account: loans create deposits, repayments destroy money, and central banks set the price of reserves.
• OSFI and the AMF. Capital rules for federally regulated deposit takers, and for the Quebec deposit institutions the AMF regulates.

In Canada, federally regulated deposit-taking institutions are supervised by the Office of the Superintendent of Financial Institutions, which sets their capital and liquidity guidelines, and the Financial Consumer Agency of Canada explains borrowing and credit products to consumers. Both are worth reading alongside the central bank's own explanations.

Who publishes this explanation, and what is it for?

This is economics, not investment advice, and it describes no product. It sits among the money principles because the vocabulary of money creation is in circulation, and a reader who knows the real mechanism can judge any claim made in its name.

Reading it is free. The firm behind this site sells life insurance, and it is paid by insurer commission if a policy is bought. An accurate account of how money is created is useful to you whether or not you ever become a client, and the accurate arguments about borrowing costs and spent savings never needed the multiplier in the first place.