UPSC Prelims 2021 Q11: Money Multiplier Determinants — Explained
The money multiplier in an economy increases with which one of the following?
- Increase in the Cash Reserve Ratio in the banks
- Increase in the Statutory Liquidity Ratio in the banks
- Increase in the banking habit of the people
- Increase in the population of the country
Answer: (c) Increase in the banking habit of the people
Statement-wise explanation
- a: incorrect — The Cash Reserve Ratio (CRR) is the share of deposits a bank must keep as cash with the RBI. A higher CRR raises the reserve-deposit ratio, so banks have less of each deposit to lend and less money is created from it. The multiplier therefore falls. RBI's April 2026 Monetary Policy Report shows the reverse case: after CRR cuts (100 bps, to 3% of NDTL, in Sept–Nov 2025), the money multiplier rose to 5.99 on 15 March 2026, up from 5.72 a year earlier.
- b: incorrect — The Statutory Liquidity Ratio (SLR) makes banks hold a set share of their NDTL in liquid assets such as government securities, gold and cash. Money held this way cannot be lent to the public. A higher SLR therefore shrinks the loanable part of deposits and weakens credit creation. It lowers the multiplier rather than raising it.
- c: correct — The multiplier depends on the currency-deposit ratio (c) and the reserve-deposit ratio (r): m = (1 + c) / (c + r). A stronger banking habit means people keep more of their money as bank deposits and less as cash, so c falls. More money then stays in banks to be lent and re-deposited, and m rises. Since r is below 1, a lower c always gives a higher m.
- d: incorrect — Population is not in the multiplier formula. The multiplier depends only on how people split their money between cash and deposits, and on how much of their deposits banks hold as reserves. A larger population can change the total amount of money in use without changing that ratio.
How to eliminate
Two options fall away on basic knowledge. CRR and SLR are both tools that tie up part of banks' deposits, so raising either one reduces lending and can only lower the multiplier. That leaves banking habit and population. The multiplier is a ratio (money supply ÷ reserve money), and a pure headcount does not change a ratio of behaviours. Banking habit does, because it moves money from cash into deposits that banks can lend. Facts to remember: m = (1 + c)/(c + r). Anything that lowers c (more banking, less cash) or lowers r (CRR cut, SLR cut) raises the multiplier.
Know more
Money multiplier = Broad money (M3) ÷ Reserve money (M0)
Reserve money (M0, also called high-powered money) is the money the RBI itself creates. It is currency in circulation plus bankers' deposits with the RBI plus 'other' deposits with the RBI. Banks lend out part of each deposit. The loans come back into banks as new deposits, which are lent again. In this way each rupee of M0 supports several rupees of M3.
The formula is m = (1 + c) / (c + r)
- c = currency-deposit ratio. It reflects the public's behaviour: how much money people hold as cash rather than as deposits.
- r = reserve-deposit ratio. It reflects policy (CRR) and banks' own choices.
| Change | Effect on c or r | Effect on multiplier |
|---|---|---|
| CRR raised | r rises | Falls |
| CRR cut | r falls | Rises |
| Banking habit / digital payments spread | c falls | Rises |
| Precautionary cash hoarding (festivals, crises) | c rises | Falls |
| Banks hold excess reserves | r rises | Falls |
Indian evidence: RBI notes that in severe shocks such as COVID-19 or the 2008 global financial crisis, households hold more cash, which raises c and makes reserve money and broad money move apart. In April 2026, RBI reported that the multiplier rose to 5.99 (from 5.72 a year earlier). It credited the CRR cuts, even though c had gone up.
SLR caveat: SLR does not appear in the simple formula. It still reduces how much of a deposit can be lent to the private sector, so for exam purposes, a higher SLR means weaker credit creation.
Traps: The multiplier is a ratio. It is not the same thing as the level of money supply. Open market operations change M0, the base, not m.
NCERT Concepts to Revise
- Money multiplier: The question asks what raises this ratio of money supply to reserve money, so its definition is the starting point.
- Credit creation: Each option has to be judged by how it speeds up or slows down the cycle of lending and re-depositing.
- Cash Reserve Ratio: One option changes this reserve requirement; you need to know how it limits the deposits banks can lend.
- Statutory Liquidity Ratio: One option turns on this liquid-asset requirement and what it does to banks' loanable funds.
- Money supply: The multiplier links reserve money to the public's money stock, so you need a clear idea of what money supply measures.
- Net Demand and Time Liabilities: Both CRR and SLR are set as shares of NDTL, so this base explains what they apply to.