The Concept of the Money Multiplier Effect

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The concept of the money multiplier effect came into being early in the 20th century, on the heels of a significant change in monetary and banking policy occurring during 1929. Rampant news of bank failures during this time created panic among depositors, who withdrew their money in great numbers. Since there was no security against losses for depositors with banks that failed. News of such failures therefore caused depositors to rush to withdraw their money in an attempt to avert too great a loss of money from the failure of these banks. Since banks did not have sufficient funding to cover all their deposits, the financial system failed, and so did the economy, ultimately leading to the Great Depression (Kaplan, 2003). To create more security for banks and depositors, President Roosevelt and his administration founded the Federal Deposit Insurance Agency (FDIC). This provided assurance to depositors and account holders that, even were banks to fail, a federally guaranteed insurance fund would cover losses so that depositors would not lose their money. This created more stability for banks and the economy. For this funding to function effectively, a policy would need to be in place to ensure that insurance funding would be available. This is where the money multiplier effect begins to play a role. The multiplier effect is the result of banks providing loans for their customers. At the same time, banks are required to hold a certain percentage of deposits as reserves,

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