UPSC Prelims 2019 Q90: Indian Economy – Monetary Policy & Money Supply
- (a) Increase in the cash reserve ratio
- (b) Increase in the banking habit of the population
- (c) Increase in the statutory liquidity ratio
- (d) Increase in the population of the country
Answer: (b) Increase in the banking habit of the population
Explanation
Money Multiplier: Determinants
| Factor | Effect on Money Multiplier |
|---|---|
| Increase in CRR | DECREASES multiplier (banks lend less) |
| Increase in banking habit / financial inclusion | INCREASES multiplier - more currency deposited, less held as cash, so higher deposit-multiplication |
| Increase in SLR | DECREASES multiplier (banks hold more in govt securities, lend less) |
| Increase in population size | Ambiguous - depends on banking habit, not size |
Money multiplier (m) = (1 + c) / (c + r), where c = currency-deposit ratio, r = reserve-deposit ratio. When banking habit rises, c falls, so m rises.
Answer: (b) Increase in the banking habit of the population.
Why each option is right or wrong
- (a) Incorrect. Higher CRR reduces money multiplier (banks must reserve more, lend less).
- (b) CORRECT. Higher banking habit means less cash held by public, more money in deposit form - increases money multiplier significantly.
- (c) Incorrect. Higher SLR reduces multiplier - banks hold more in govt securities, lend less.
- (d) Incorrect. Population size itself doesn't affect multiplier - only banking behaviour does.
Key point
Money multiplier m = (1+c)/(c+r). c = currency-deposit ratio. r = reserve-deposit ratio (CRR+SLR+excess). Multiplier RISES when c drops (better banking habit) and r drops (lower CRR/SLR).
Remember
The money multiplier in an economy increases with an increase in the banking habit of the population. When people hold less cash and deposit more in banks, the currency-deposit ratio falls, allowing banks to multiply deposits through lending more times. Higher CRR/SLR reduces the multiplier; population size alone does not affect it.
Common mistakes
- Confusing broader monetary aggregates (M0, M1, M3) with the multiplier.
- Assuming any inclusion measure raises multiplier - it must specifically lower currency-holding ratio.
- Not knowing Jan Dhan / UPI / digital payments raise banking habit -> lower c -> higher multiplier.
Exam tip
Money supply (M) = Money multiplier (m) x Monetary base (H). H = currency + reserves = RBI's liability. m depends on public's cash preference (c) and banks' reserve ratio (r). Financial inclusion drives m upward.
Sources
- NCERT Class 12 - Macroeconomics (Money creation and multiplier)
- RBI - Report on Monetary Policy Framework