When a RM50,000 deposit is made, the bank does not hold all this amount in reserve but lends out a significant portion, e.g., RM40,000. This loan is then deposited into another bank and becomes available for further lending minus the required reserves. This cycle continues across many banks, multiplying the initial deposit into a larger amount of total money created through each successive loan and deposit. Assuming a reserve requirement or cash ratio of 20%, the money multiplier is 5 (1/0.20), and the initial deposit can theoretically expand the money supply up to RM250,000 (5 x RM50,000).

The reserve requirement sets the minimum reserves that banks must hold against deposits, thus influencing how much of each deposit banks can lend out, affecting the money multiplier and the money supply. A lower reserve requirement increases the money multiplier, allowing for more loan creation and expanding the money supply, while a higher requirement contracts it. However, this control is imperfect as it doesn't account for banks' tendencies to hold excess reserves or for changes in depositor behavior, both of which can limit the central bank's ability to control the money supply effectively. Thus, while the reserve requirement is a powerful tool, its effectiveness is moderated by real-world banking practices .

The reserve ratio determines the proportion of total deposits that a bank must hold in reserve and not lend out. A lower reserve ratio means that banks can loan out a larger portion of their deposits, thus increasing the money multiplier. The money multiplier is calculated as the inverse of the reserve ratio (e.g., a reserve ratio of 5% leads to a money multiplier of 1/0.05 = 20). This larger multiplier means that banks can create more money from the same amount of reserves, thereby increasing the money supply. Conversely, a higher reserve ratio reduces the money multiplier, limiting the banks' ability to create additional money and thereby decreasing the money supply .

Fractional-reserve banking allows banks to keep only a fraction of their deposits as reserves, lending out the remainder to foster economic expansion. This system inherently means the creation of money through repeat lending and redeposit cycles, leading to a multiple increase in the money supply. However, the central bank's control is imperfect because it cannot dictate banks' lending practices or predict depositor behavior, such as the amount of cash households decide to hold or deposit. These variables introduce uncertainties and fluctuations in the money supply that are beyond the direct control of the central bank, making its regulation a complex task .

The central bank can contract the money supply by selling government bonds, which decreases bank reserves and their capability to issue loans, or by raising reserve requirements to limit the amount banks can lend from their deposits. It can also increase the discount rate to dissuade banks from borrowing additional reserves. However, these mechanisms can be undermined by banks holding excess reserves which reduces loan creation, or by unexpected shifts in economic conditions prompting changes in deposit and lending behaviors by consumers and banks, which can counteract the central bank's contractionary policies .

Banks might choose to hold excess reserves to ensure they have enough liquidity for operational needs such as cashing paychecks and settling transactions with other banks. Holding excess reserves reduces the funds available for lending, which in turn contracts the money supply as fewer loans lead to a lower overall money multiplier effect. If banks universally increase their excess reserves without changing the total reserve ratio, the money multiplier remains constant, and there's no change to the money stock .

Changes in the central bank's discount rate, the interest rate charged on loans to commercial banks, directly affect banks' borrowing behavior. A lower discount rate reduces the cost of borrowing additional reserves, encouraging banks to extend more loans, thereby increasing the money supply through a higher money multiplier effect. Conversely, a higher discount rate makes reserves more expensive, discouraging banks from lending as aggressively and contracting the money supply. However, the impact can be moderated by banks' strategies on reserve holdings or broader economic factors affecting loan demand and availability .

Households play a crucial role in determining the money supply by deciding how much money to deposit in banks. More deposits result in more reserves for banks, which allows for more loans and hence increases the money supply. Conversely, fewer deposits reduce bank reserves and the potential amount of loans, decreasing the money supply. On the other hand, the central bank influences the money supply through monetary policy tools such as open market operations, reserve requirements, and discount rates. By buying or selling government bonds, adjusting reserve requirements, or changing the discount rate, the central bank can indirectly influence banks' capacity to create money. However, the central bank's control is imperfect as it cannot directly control household deposits or bank lending behaviors, which also affect the total money created .

Depositors influence monetary policy effectiveness through their choices of how much money to deposit. Higher deposits bolster bank reserves, allowing for more loans and increased money supply, while reduced deposits limit this potential. Bankers' preferences for holding excess reserves over lending directly affect the money multiplier, as higher excess holdings reduce the money supply than expected by central bank policies. These independent behaviors introduce variables that can either amplify or dampen the intended outcomes of the central bank's monetary policy actions, such as changes in reserve requirements or open market operations, ultimately adding complexity and uncertainty to policy effectiveness .

Through open market operations, the central bank can purchase government bonds to inject liquidity into the banking system, increasing bank reserves and thus expanding the money supply as banks can lend more. Conversely, selling government bonds reduces bank reserves and contracts the money supply. However, these operations may be limited by factors such as banks' preference to hold excess reserves or changes in consumer confidence that affect deposit and lending behaviors, which are beyond the central bank's direct control. Consequently, while impactful, open market operations are not foolproof in controlling the money supply .