Money multiplier refers to deposits creation by the commercial banks as some multiple of deposits initially received by these bank. The value of multiplier depends on the Legal Reserve Ratio (LRR). Suppose banks receive initially a deposit of Rs 10,000. Further Suppose than LRR is 0.2. Bank keep Rs 2,000 as reserves and lend the rest. The borrowers spend this money. Those who receive the money from the borrowers redeposit the same into their respective bank account. This leads to fresh deposits of Rs 8,000. Banks again keept 20% of it, i.e., Rs 1,600 as reserves and lend the rest 6,400 which again comes back into the banking system by the same process. In this way new deposits go on being created but every new creation becomes smaller and smaller. The total deposit creation is 1/LRR i.e., 1/0.2 times. It comes to 5 times and total deposits become Rs 50,000 worth.
