Question 39 from UPSC CSE 2019 - Economics

Question

The money multiplier in an economy increases with which one of the following?

IASCODEX · Accepted Answer

Correct Option: B. Increase in the banking habit of the population

Strategy: The central idea is to understand that the money multiplier is tied to how much money banks can create based on public deposits. An increase in the banking habit means people deposit more money rather than holding cash, enabling banks to lend more. By contrast, higher reserve or liquidity ratios restrict lending and do not aid the multiplier. Population growth alone does not impact banking operations directly. Hence, increased banking habit is the correct answer.

Key Info: The money multiplier is the factor by which an initial increase in the monetary base (high-powered money, such as central bank money) is magnified to result in a greater increase in the total money supply. Formulaically, it is the inverse of the reserve ratio: Money Multiplier = 1 / Reserve Ratio. The money multiplier effect depends largely on the proportion of money people keep in banks (demand and time deposits) versus as cash on hand. A lower cash reserve ratio (CRR) or statutory liquidity ratio (SLR) allows banks to lend more, increasing the multiplier. By contrast, higher CRR or SLR restrict bank lending, lowering the multiplier. The 'banking habit' describes the tendency of the population to use bank deposits rather than holding currency in cash; as this habit strengthens, banks receive more deposits and are able to create more credit via fractional-reserve banking, leading to a higher money multiplier. Merely increasing the population does not directly increase the multiplier unless it is accompanied by greater deposit mobilization and a stronger banking habit. The Reserve Bank of India regulates CRR and SLR as monetary tools, while financial literacy and access initiatives (like Jan Dhan Yojana) aim to increase the banking habit.

IASCODEX · Answer

Option A: Increase in the cash reserve ratio

IASCODEX · Answer

Option C: Increase in the statutory liquidity ratio

IASCODEX · Answer

Option D: Increase in the population of the country