Money multiplier increases with which factor? UPSC Prelims PYQ 2021
The money multiplier in an economy increases with which one of the following?
- Increase in the Cash Reserve Ratio in the banks
- Increase in the Statutory Liquidity Ratio in the banks
- Increase in the banking habit of the people
- Increase in the population of the country
Explanation
Option (c) is correct
- An increase in the banking habit refers to more people depositing their money into banks rather than keeping it as cash.
- Effect on Money Multiplier: When people deposit more money into banks, banks have more reserves available to lend out. This increase in deposits allows banks to create more loans, thereby increasing the money supply and boosting the money multiplier.
Option (a) is incorrect
- The Cash Reserve Ratio is the percentage of a bank’s total deposits that must be held as reserves with the central bank and cannot be used for lending.
- Effect on Money Multiplier: An increase in the CRR means banks must hold more money as reserves and cannot use it for lending. This reduces the amount of money banks can lend out, thereby decreasing the money multiplier.
Option (b) is incorrect
- The Statutory Liquidity Ratio is the percentage of a bank’s net demand and time liabilities that must be kept in the form of liquid assets, such as cash, gold, or government securities.
- Effect on Money Multiplier: An increase in the SLR means banks need to keep a larger proportion of their deposits in liquid assets. This reduces the amount available for lending, thus decreasing the money multiplier.
Option (d) is incorrect
- An increase in the population means more people are present in the economy.
- Effect on Money Multiplier: While a growing population could potentially increase the demand for money and financial services, it does not directly influence the money multiplier. The effect of population growth on the money multiplier is indirect and depends on factors like increased banking habits and economic activity.
Answer: (c) Increase in the banking habit of the people; Difficulty Level: Easy
