Suppose an initial cash deposit of INR 100 crores has been made in a commercial bank where a total credit of INR 500 crores has been created in the economy. The required reserve ratio in this country is.............
Suppose an initial cash deposit of INR 100 crores has been made in a commercial bank where a total credit of INR 500 crores has been created in the economy. The required reserve ratio in this country is.............
Solution
Option 1: 5% -> If RRR is 5%, money multiplier would be 1/0.05 = 20, creating INR 2000 crores, not 500.
Option 2: 10% -> If RRR is 10%, money multiplier would be 1/0.10 = 10, creating INR 1000 crores, not 500.
Option 3: 20% -> If RRR is 20%, money multiplier would be 1/0.20 = 5, creating INR 500 crores, which matches.
Option 4: 25% -> If RRR is 25%, money multiplier would be 1/0.25 = 4, creating INR 400 crores, not 500.
Hence, Option 3: 20% -> The money multiplier formula is: Money Multiplier = Total Credit / Initial Deposit = 500/100 = 5. The required reserve ratio (RRR) is calculated as: RRR = 1/Money Multiplier = 1/5 = 0.20 or 20%. This means banks must keep 20% of deposits as reserves and can lend out the remaining 80%, which creates a multiplier effect of 5 in the economy. -> correct
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