UPSC Prelims 2021 Q11: Indian Economy – Fiscal Policy & Budget
- (a) Increase in the Cash Reserve Ratio in the banks
- (b) Increase in the Statutory Liquidity Ratio in the banks
- (c) Increase in the banking habit of the people
- (d) Increase in the population of the country
Answer: (c) Increase in the banking habit of the people
Explanation
Money Multiplier: What Increases It?
Money multiplier formula: m = (1 + c) / (c + r) where c = currency-deposit ratio, r = reserve ratio (CRR + excess reserves).
| Factor | Effect on Multiplier | Reason |
|---|---|---|
| Increase in CRR | DECREASES | Higher r means banks lend less per rupee of deposits - multiplier falls. |
| Increase in SLR | DECREASES | SLR ties up bank funds in G-Secs, reducing lending capacity. |
| Increase in banking habit of people | INCREASES | People hold LESS cash and MORE deposits (c falls). Lower c raises the multiplier. |
| Increase in population | NEUTRAL | Population by itself does not change c or r - it changes aggregate money demand, not the multiplier. |
Higher banking habit = lower c = higher multiplier. Answer: (c).
Answer: (c) Increase in the banking habit of the people.
Why each option is right or wrong
- (a) Incorrect. Higher CRR REDUCES the multiplier because banks must hold more reserves and can lend less.
- (b) Incorrect. Higher SLR REDUCES the multiplier by tying up funds in G-Secs.
- (c) CORRECT. Increased banking habit means people keep money in bank deposits rather than cash. This lowers the currency-deposit ratio (c), which raises the money multiplier.
- (d) Incorrect. Population increase affects money demand, not the multiplier.
Key point
Money multiplier m = (1+c)/(c+r). LOWER c (banking habit up) or LOWER r (CRR/SLR down) = HIGHER multiplier. Higher banking habit shifts cash into deposits, letting banks lend more, expanding broad money faster.
Remember
The money multiplier increases when the banking habit of the people rises. Higher banking habit means people hold less cash and more bank deposits, lowering the currency-deposit ratio (c) and raising m = (1+c)/(c+r). CRR/SLR hikes reduce the multiplier.
Common mistakes
- Confusing CRR (Cash Reserve Ratio) with SLR (Statutory Liquidity Ratio). Both reduce multiplier but through different mechanisms.
- Not knowing that Jan Dhan accounts and PMJDY (2014) boosted India's banking habit and hence the multiplier.
- Assuming population automatically raises money supply. Population raises demand for money, but only banking habit changes the multiplier.
Exam tip
To raise the multiplier: (i) cut CRR/SLR (RBI action), (ii) build banking habit (Jan Dhan, financial inclusion), (iii) reduce cash holding by public. UPI, IMPS and digital payments raise India's multiplier by shifting transactions out of cash.
Sources
- NCERT Class XII Macroeconomics - Chapter 3: Money and Banking
- RBI Bulletin - Monetary Aggregates and Multiplier