Final answer:
The money multiplier formula, M = 1/R, is used to calculate the theoretical maximum amount of new money that can be created in a banking system from new deposits. It uses the reserve ratio to determine how much money banks can lend out.
Step-by-step explanation:
The formula used to calculate the maximum amount of new money that may be created from any given amount of money in a banking system is known as the money multiplier formula. This formula is foundational in understanding how banks can lend out more than they hold in reserves, effectively expanding the money supply within an economy. To calculate the potential increase in money supply, the money multiplier (M) is typically the inverse of the reserve ratio (R): M = 1/R. For example, if a bank has a reserve ratio of 10%, the money multiplier would be 1/0.10, which equals 10. This indicates that for every unit of currency deposited, up to 10 units of currency can be created through lending.
Moreover, if we have an initial monetary value, we can apply the money quantity equation of money: MV = PQ. Assume V (velocity of money) equals 3, M (money supply) is 4,000 billion, and P (price level) is 100. Substituting into the equation, we can further solve for Q, which represents the real output of goods and services.