Q. Consider the following factors:
1.An increase in the Cash Reserve Ratio (CRR)
2.An increase in the Currency Deposit Ratio (CDR)
3.A shift in public preference from Demand Deposits to Time Deposits
Which of the factors given above will lead to a decrease in the value of the Money Multiplier (M0M3) in the economy?
Answer: B
Notes:
Explanation:
The Money Multiplier is the ratio of Broad Money (M3) to Reserve Money (M0) and indicates the extent of money creation by commercial banks.
- Increase in CRR: Correct. A higher CRR means banks must hold more cash reserves, reducing their lending capacity, which slows down the process of credit creation and decreases the money multiplier.
- Increase in CDR: Correct. If the public holds more cash (higher CDR), less money is deposited in the banking system. This shrinks the base of loanable funds, reducing the potential for credit creation and thus decreasing the money multiplier.
- Shift from Demand Deposits to Time Deposits: Incorrect. This shift generally increases the money multiplier, as time deposits are included in M3 but not M1, and banks can lend a larger proportion of time deposits (subject to SLR/CRR). A larger base of term deposits supports a higher M3 relative to M0, generally increasing the multiplier.
