Q. Consider the following statements regarding the money supply and banking system in a modern economy:
1.High-powered money refers to the currency issued by the central bank and held by the public and commercial banks.
2.Commercial banks are mandated to keep the entire amount of public deposits as reserves and cannot lend them out.
Which of the statements given above is/are correct?
Answer: A
Notes:
Explanation:
- High-powered money (also called reserve money or monetary base) refers to the currency issued by the central bank that is held by the public and commercial banks. This forms the basis for credit creation in the economy.
- Commercial banks do not keep the entire amount of public deposits as reserves. They retain only a portion (known as reserve ratio) to meet withdrawal demands and lend out the rest to earn interest. This process enables credit creation, as described in the story of Lala the goldsmith.
Source: Laxmikant (Polity)
