UPSC Prelims 2021 GS Paper I · Q11 of 98 Economy medium

The money multiplier in an economy increases with which one of the following?

  1. (a) Increase in the Cash Reserve Ratio in the banks
  2. (b) Increase in the Statutory Liquidity Ratio in the banks
  3. (c) Increase in the banking habit of the people ✓ UPSC's answer
  4. (d) Increase in the population of the country

Why the answer is (c)

• The money multiplier (broad money ÷ reserve money) rises when a larger share of money stays inside the banking system to be re-lent.

• A stronger banking habit means people hold less cash and more deposits, lowering the currency-deposit ratio and raising the multiplier — option (c).

• Higher CRR (a) forces banks to park more with the RBI and higher SLR (b) locks funds in government securities; both reduce lending and hence the multiplier.

• Population size (d) has no direct bearing on the multiplier.

• Hence option (c).

Why the other options are wrong

(a) Increase in the Cash Reserve Ratio in the banks
Higher CRR reduces lendable funds and lowers the multiplier.
(b) Increase in the Statutory Liquidity Ratio in the banks
Higher SLR locks funds in securities and lowers the multiplier.
(d) Increase in the population of the country
Population has no direct effect on the multiplier.

Asked in the GS Paper I of the UPSC Civil Services Preliminary Examination 2021, held on 10 October 2021. Question and answer key: Union Public Service Commission. Explanation: UPSC Answer Check.

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