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The Credit Cruncher was conceived to help you to keep up to date with credit crunch and recession developments, it provides some helpful credit crunch advice and it addresses personal debt. The Credit Cruncher also seeks to explain how the credit crunch started and shed some light on the worldwide recession. Recently, we have begun to look at how BREXIT will affect the UK economy. Please feel free to leave comments where relevant.

23 Jun 2008

The Multiplier

The multiplier is a principle which demonstrates how the same money can be made to work harder within the economy. It may apply to both spending or saving but is easiest illustrated through spending:
If you imagine a worker receives a bonus of $100, he basically has three options, he could leave the money in a drawer, he could spend the money or save it in the bank.
If he spends all of the money on a special meal for his family, then his family have benefited to the tune of a $100 meal, and the restaurant benefits from the $100 spent. If the restaurant spends that $100 on new napkins, then another trader has had benefit from what is basically the same $100 in a relatively short time.
If the worker places the money in a drawer, then the benefits of that $100 are lost to the economy, and you might think the same if he banks it, but this is not the case.. Banks are obliged to retain only a proportion of deposits, and will utilise the rest in loans and investments. If banks are (for example) instructed to retain 25% of deposits, 75% can make it's way back into the economy, and if that $75 is also banked, 75% of the $75 can also go back into the economy meaning that already the muliplier effect has produced $131.25 (75+56.25) and can continue until $400 ends up sloshing around because of the original $100 deposit.

This idea may be a little difficult to get your head around, but the outcome is that when we decide NOT to spend, we deprive the economy of not just our money, but our money multiplied. So if we are going to be careful about what we spend (and I for one would advise that individuals should specifically ensure that they are not spending more than they can afford), there will be effects on the economy which will actually increase the credit crunch in the short-term.
Ultimately this may have an effect on money saved if people realise their savings to pay off loans and credit card debt or even to pay monthly bills. the combination of factors will slow down the economy, reducing spending, suppressing wage rises and making credit harder to obtain until something happens to restore market confidence.

The old adage 'it will get worse before it gets better' applies to no situation better than it does the credit crunch.

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