Question 3 from UPSC CSE 2021 - Economics

Question

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

IASCODEX · Accepted Answer

Correct Option: C. Increase in the banking habit of the people

Strategy: Eliminate options that increase reserve requirements (CRR, SLR) as they lower the money multiplier. Dismiss population increase as a standalone factor. Identify the increase in banking habit as the key driver for a higher money multiplier.

Key Info: **Money Multiplier**
The money multiplier indicates the increase in money supply for every unit of reserves in the banking system. It is calculated as 1 divided by the reserve ratio, meaning lower reserve ratios lead to a higher multiplier.

**Key Factors**

*   **Reserve Ratios**
    *   **Cash Reserve Ratio (CRR):** The portion of total deposits banks must keep with the central bank as cash.
    *   **Statutory Liquidity Ratio (SLR):** The share of deposits banks must maintain in liquid assets like gold or government securities.
    *   Higher CRR and SLR reduce lendable resources, thus lowering the money multiplier.

*   **Banking Habit**
    *   This refers to the proportion of people saving their money in banks rather than holding cash.
    *   A stronger banking habit increases funds available for credit creation, which magnifies the money multiplier.

*   **Population**
    *   An increase in population only impacts the money multiplier if it is accompanied by a greater inclination to use banking services.

**Regulation and Principle**
Central banks regulate CRR and SLR to manage credit expansion and the money supply. In India, these are statutory tools for the RBI under the Reserve Bank of India Act, 1934, and the Banking Regulation Act, 1949. The core principle is that each deposit initiates a chain of further deposits and loans, constrained by reserve requirements and the public's preference for holding currency versus bank deposits.

IASCODEX · Answer

Option A: Increase in the Cash Reserve Ratio in the banks

IASCODEX · Answer

Option B: Increase in the Statutory Liquidity Ratio in the banks

IASCODEX · Answer

Option D: Increase in the population of the country