What would be the impact on the economy if people start holding more currency in hand and less in deposits ?
- A.Money demand will increase
- B.Money multiplier will decrease
- C.Money multiplier will increase
- D.Money demand will decrease
Correct answer
Explanation
The correct answer is B, Money multiplier will decrease. Banks can create credit only from money deposited with them, so when people keep more cash at home, less is lent and re-lent, and the multiplier falls.
The money multiplier is the ratio of broad money to reserve money (high-powered money). In its simple form it equals (1 + c) divided by (c + r), where c is the currency-deposit ratio chosen by the public and r is the reserve ratio of banks. A rise in c makes the denominator grow faster than the numerator, so the multiplier becomes smaller. This is why the RBI watches cash holding habits and why moves towards digital payments and bank deposits tend to raise the multiplier.
A and D are wrong because the question is about how deposits create money, not about how much money people wish to hold; demand for money depends mainly on income and interest rates. C is wrong because more cash in hand lowers the multiplier, it does not raise it.
Exam tip: higher currency-deposit ratio or higher reserve ratio means a lower money multiplier.
Practice Questions
View allConsider the following statements:
I. The Second Five-Year Plan sought to promote development which would establish socialistic pattern of society in India.
II. Between 1966 and 1969, three Annual Plans were formulated.
III. The Ninth Five-Year Plan could not take off at its stipulated time in the 60th year of India's Independence.
Which of the statements given above are correct?
- A.I and II only
- B.I and III only
- C.II and III only
- D.I, II and III
Show answer
Statements I and II are true, but the Ninth Plan began in 1997, the fiftieth year of Independence, not the sixtieth.
Read the full explanation →According to the National Multi-dimensional Poverty Index (MPI) constructed by the NITI Aayog, a household is considered deprived if 1. a single member of the household is identified as under-nourished 2. the body mass index of a woman member, between 15 years and 49 years of age, is below 18.5 kg/m2 Select the correct answer using the code given below.
- A.1 only
- B.2 only
- C.Both 1 and 2
- D.Neither 1 nor 2
Show answer
Under the nutrition indicator, a household is deprived if any one eligible member is undernourished, and a woman of 15 to 49 with a BMI below 18.5 counts as undernourished.
Read the full explanation →Which one of the following canons of taxation was not advocated by Adam Smith?
- A.Canon of equality
- B.Canon of certainty
- C.Canon of convenience
- D.Canon of fiscal adequacy
Show answer
Adam Smith laid down four canons of taxation, and fiscal adequacy was not one of them; it was added by later economists.
Read the full explanation →Which one of the following is a good statistic to evaluate where an economy stands in the financial cycle ?
- A.Tax/GDP Ratio
- B.Fiscal Deficit/GDP Ratio
- C.Household Consumption/GDP Ratio
- D.Credit/GDP Ratio
Show answer
The financial cycle is the rise and fall of credit and asset prices, and the ratio of credit to GDP shows how far borrowing has run ahead of the economy.
Read the full explanation →According to John Maynard Keynes, employment depends upon
- A.aggregate demand
- B.aggregate supply
- C.effective demand
- D.rate of interest
Show answer
In Keynes's theory the level of employment in an economy is fixed by effective demand, the level of total spending at which aggregate demand equals aggregate supply.
Read the full explanation →