Which of the following statements about factors affecting the Money Multiplier (MM) is/are correct?
1. Cash held by individuals acts as a leakage and reduces the money multiplier.
2. Higher reserves held by banks with the RBI increase the money multiplier.
3. A higher Cash Reserve Ratio (CRR) reduces the banking system's capacity to create money.
Show answer & explanation
Correct answer: A
Explanation
The correct answer is option 1 i.e. Only 1 and 3.
The Money Multiplier (MM) is inversely related to the reserve and currency leakage ratios. Statement 1 is correct because cash held by the public (currency leakage) cannot be loaned out by banks, reducing the total credit created. Statement 3 is correct because a higher Cash Reserve Ratio (CRR) forces banks to keep more funds idle with the RBI, leaving less for lending. Statement 2 is incorrect because higher reserves actually decrease the multiplier by limiting the bank's ability to multiply deposits.