Question

Which one of the following statements is CORRECT?

• A. Higher the cash reserve ratio, smaller the money multiplier.
• B. Higher the cash reserve ratio, larger the money multiplier.
• C. If banks hold all deposits as reserve, larger the money multiplier.
• D. Cash reserve ratio does not influence the money multiplier.

Hint:

The money multiplier is inversely related to the cash reserve ratio: a higher CRR means a smaller money multiplier.

Answer 1

The Correct Option is A

Step 1: Understand the cash reserve ratio (CRR) and money multiplier.
The cash reserve ratio (CRR) is the proportion of a bank's total deposits that must be kept in reserve with the central bank. The money multiplier is a factor that determines how much money supply will increase as a result of an initial deposit. It is inversely related to the CRR.
Step 2: Analyze the options.
- Option (A) is correct. The money multiplier is given by \( \frac{1}{\text{CRR}} \). A higher CRR means that banks must hold more reserves, reducing the amount of money they can lend out, and thus reducing the money multiplier.
- Option (B) is incorrect because a higher CRR reduces the money multiplier, not increases it.
- Option (C) is incorrect because if banks hold all deposits as reserves (i.e., CRR = 1), the money multiplier becomes 1, not larger.
- Option (D) is incorrect because the cash reserve ratio directly influences the money multiplier.
Final Answer: \[ \boxed{\text{Higher the cash reserve ratio, smaller the money multiplier.}} \]