What would happen to the “money multiplier” in an economy, if the cash reserve ratio (CRR) is reduced?

• The money multiplier describes how an initial deposit leads to a greater final increase in the total money supply.

• When an initial deposit is made in the banks, the banks can further lend loans by keeping a certain percentage as Cash Reserve Ratio (CRR). For instance, if a deposit of Rs. 100 is made into the banks, then the banks would have to keep Rs. 10 as reserve (considering CRR as 10%) and they may lend Rs. 90 in the form of loans. Now, when this Rs. 90 is deposited into the bank again, the bank would keep Rs. 9 as reserves and lend remaining Rs. 81 in the form of loans. Thus, the initial deposit of Rs. 100 with the banks has led to the creation of money by the banks in the form of new loans.

• This is referred to as “Money Multiplier”. It is calculated as (1/R) where R is the “Reserve” requirement. Hence, the money multiplier is inversely proportional to the reserve requirement, i.e., as the CRR is reduced, the money multiplier would increase.