Question

“When initial deposits in the credit creation process remains same, the total amount of credit created rises as the value of money multiplier increases.”

Defend or refute the above statement with the help of hypothetical numerical example.

Hint:

Credit created = Initial deposit x Money multiplier, and multiplier = 1/RR. Fix the deposit at Rs. 1,000 and compare multiplier 4 (credit Rs. 4,000) with multiplier 5 (credit Rs. 5,000). The statement is defended.

Answer 1

Step 1: Understand the statement:
In credit creation, banks keep only a part of each deposit as reserve and lend the rest. The lent money returns to the banking system as new deposits.
The statement says that if the initial deposit stays the same, a larger money multiplier gives more total credit. We must test this with numbers.

Step 2: Write the formulas:
Money multiplier = 1 / RR, where RR is the Required Reserve Ratio.
Total credit created = Initial deposit x Money multiplier.

Step 3: Take a hypothetical example:
Keep the initial deposit fixed at Rs. 1,000 in both cases. Change only the multiplier.
Case I: RR = 25 percent, so multiplier = 1 / 0.25 = 4.
Case II: RR = 20 percent, so multiplier = 1 / 0.20 = 5.

Case	Initial deposit (Rs.)	Money multiplier (1/RR)	Credit created (Rs.)
I	1,000	4	1,000 x 4 = 4,000
II	1,000	5	1,000 x 5 = 5,000

Step 4: Compare the two cases:
The initial deposit is the same in both cases. The multiplier rises from 4 to 5.
Credit created rises from Rs. 4,000 to Rs. 5,000. So credit and multiplier move in the same direction.

Final Answer:
The statement is defended. With the initial deposit fixed, a higher money multiplier gives more total credit, as the example shows (Rs. 4,000 against Rs. 5,000).