CAPF AC 2023 Q29: Indian Economy – Monetary Policy & Money Supply
- (a) remain unchanged.
- (b) decrease.
- (c) increase.
- (d) have ambiguous impact.
Answer: (c) increase.
Explanation
Cash Reserve Ratio and money supply
How to think: the CRR is the share of deposits that banks must keep with the RBI as cash.
That money earns nothing and cannot be lent.
If the CRR is lowered, banks have more money to lend.
More lending means more money in the economy.
| RBI action | Effect on banks | Money supply |
|---|---|---|
| CRR lowered | More funds free for loans | Increases |
| CRR raised | Less funds free for loans | Decreases |
The multiplier: the money multiplier is roughly 1 ÷ reserve ratio.
A lower ratio gives a bigger multiplier.
When the RBI cuts the CRR: when it wants to boost growth, as it did in March 2020.
It raises the CRR to fight inflation.
Answer: (c) increase.
Why each option is right or wrong
- (a) Incorrect. A change in the CRR directly changes how much banks can lend.
- (b) Incorrect. Money supply falls when the CRR is raised, not lowered.
- (c) CORRECT. A lower CRR frees funds for lending, so money supply increases.
- (d) Incorrect. The direction is clear, not ambiguous.
Key point
CRR: cash kept with the RBI, no interest (RBI Act, Section 42). SLR: liquid assets kept by banks themselves (Banking Regulation Act, Section 24). Lower CRR, SLR or repo rate → more money (expansionary). Higher → less money (contractionary).
Remember
Lower CRR → more lending → more money.
Common mistakes
- Reversing the effect and saying a lower CRR reduces money supply.
- Mixing up CRR (cash with the RBI) with SLR (gold and securities with the bank).
- Thinking banks earn interest on CRR balances.
Exam tip
Educated guess: a reserve is money locked away. Lowering the lock releases money, so there is more of it around.
Sources
- NCERT Class XII Economics — Introductory Macroeconomics, Chapter 3: Money and Banking (instruments of monetary policy)
- Reserve Bank of India — Monetary Policy: instruments (Cash Reserve Ratio)