a. Define money multiplier.b. 'Credit creation is inversely related to

1.	a. Define money multiplier.b. 'Credit creation is inversely related to the reserve deposit ratio'.Justify the given statement, using a hypothetical example.
Answer» a. Money multiplier is the process by which the commercial banks create credit, based upon the reserve ratio and initial deposits. b. Reserve deposit ratio is the minimum reserves which a commercial bank must maintain as per the instructions of the Central Bank. Credit Creation = \(\frac{1}{reserved\,ratio}\) Thus, credit creation is inversely related to the reserve deposit ratio. For Example: Suppose the Reserve Ratio is 0.2 and initial deposit is Rs 1000 crores. Total Credit Created = \(\frac{1}{reserved\,ratio}\) x initital deposits = \(\frac{1}{0.2}\) x 1000 = Rs 5,000 crores. Now, suppose reserve ratio is increased to 0.5 Total Credit Created = \(\frac{1}{reserved\,ratio}\) x initital deposits = \(\frac{1}{0.5}\) x 1000 = Rs 2,000 crores. Thus, on the basis of the above illustration we can say that there exists an inverse relation between reserve and credit creation.

a. Define money multiplier.b. 'Credit creation is inversely related to the reserve deposit ratio'.Justify the given statement, using a hypothetical example.

Answer»

a. Money multiplier is the process by which the commercial banks create credit, based upon the reserve ratio and initial deposits.

b. Reserve deposit ratio is the minimum reserves which a commercial bank must maintain as per the instructions of the Central Bank.

Credit Creation = \(\frac{1}{reserved\,ratio}\)

Thus, credit creation is inversely related to the reserve deposit ratio.

For Example: Suppose the Reserve Ratio is 0.2 and initial deposit is Rs 1000 crores.

Total Credit Created = \(\frac{1}{reserved\,ratio}\) x initital deposits

= \(\frac{1}{0.2}\) x 1000

= Rs 5,000 crores.

Now, suppose reserve ratio is increased to 0.5

Total Credit Created = \(\frac{1}{reserved\,ratio}\) x initital deposits

= \(\frac{1}{0.5}\) x 1000

= Rs 2,000 crores.

Thus, on the basis of the above illustration we can say that there exists an inverse relation between reserve and credit creation.