Monetary policy: Effect of lowering the Cash Reserve Ratio (CRR). Full question: If the RBI lowers the CRR, what happens to the banking system's ability to create credit? Choose the correct option.
General Knowledge
Indian Economy
Difficulty: Easy
Choose an option
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ACredit creation rises as the money multiplier increases
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BCredit creation falls as banks must hold more idle reserves
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CNo change in credit as CRR is unrelated to reserves
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DCredit creation collapses due to higher policy rates automatically
Answer
Correct Answer: Credit creation rises as the money multiplier increases
Explanation
Given data
- Policy change: CRR reduced by the RBI.
Concept / Approach Required reserve ratio rr ↓ ⇒ excess reserves ↑ ⇒ banks can extend more loans ⇒ deposit creation expands. Money multiplier m ≈ 1/rr (simplified, ignoring leakages); when rr falls, m rises.
Step-by-step illustration Example: If rr = 4% ⇒ m ≈ 1/0.04 = 25; if rr is cut to 3% ⇒ m ≈ 1/0.03 ≈ 33.3 ⇒ higher potential for deposit/credit creation.
Final Answer Credit creation rises as the money multiplier increases.