Money, Banking & Monetary Policy› Money Supply, Money Creation & Interest Rates
The money multiplier in an economy increases with which one of the following?
Answer b.
(b) Increase in the banking habit of the population. Better banking habits mean people hold less cash and more deposits, which lowers the currency-deposit ratio and raises the money multiplier. The money multiplier is the ratio of money supply to high-powered money (reserve money): m = M/H = (1+cdr)/(cdr+rdr), where cdr is the currency-deposit ratio and rdr the reserve-deposit ratio. Since rdr is less than 1, a fall in cdr raises the multiplier. When banking habits improve, the public keeps a larger share of its money in bank deposits rather than as cash, so cdr falls and each rupee of reserve money supports more deposit creation. Raising CRR or SLR does the opposite by increasing the reserve-deposit ratio, which shrinks the multiplier.
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