ARMe

Macroeconomics XT by súbhash Dey

ObjectiveType Questions 2,1

1 Demand deposits treated by the commercial banks are called
(a) igh powered money (b) Money
(Choose the correct alternative)

(c)/Bank money (d) Time deposits

2 are called legal tenders. (Choose the correct alternative)
(a) Demand deposits (b) Time deposits
(c) Inter-bank deposits (d Currency notes and coins
3 Which of the following is not included in money supply? (Choose the correct alternative)
(a) High powered money (b) Bank money
(c) Time deposits (dInter-bank deposits
4. Supply of money refers to quantity of money (CBSE 2017) (Choose the correct alternative)
(a) a_ on 31st March (b) during any specified period of time
(c) ás on any point of time (d) during a fiscal year
5. Demand deposits include (CBSE 2017) (Choose the correct alternative)
(a) Saving account depositsand fixed deposits (b)Saving account deposits and current account deposits
(c) Current account deposits and fixed deposits (d) All types of deposits
is the main source of money in an economy. (Choose the correct alternative)
(a) Central bank of the economy (b) Commercial banking system
(c/Both (a) and (b) (d) Government
7.)Currency issued by the central bank iscalled: (Choose the correct alternative)
(a) Fiat money (b) Legal tenders
(c) High powered money (d All of the above
8. Apart from currency notes and coins, the balance in (i) held by the public in commercial banks is also
considered money since the amount in these accounts can be used to settle transactions. Such deposits are called demand

deposits because (ii) (Fill in the blanks)

9. Demand deposits created by commercial banks are called (Fill in the blank)
10: Demand deposits are not since cheques drawn on these accounts can be refused by anyone as a mode of payment.
11. Bank deposits which have fixed period to maturity, e.g. fixed deposits are referred to as (Fill in the blank)
12. M1 measure of money supply is defined as follows:
M1 = CU+DD
deposits held by commercial banks. The
where, CU is Currency (notes plus coins) held by the public and DD is net' demand (Fill in the blank)
word 'net' here implies that
13. In amodern economy, money comprises
commercial bank, and is called the
14. The currency issued by the central bank can be held by the public or by the (Fill in the blank)
or reserve money' or 'monetary base' as it ácts as basis for credit creation.
of the
15. Besides central bank, are the other type of institutions which are apart of the money-creating system
eçonomy.
who want to borrow.
(16) accept deposits fromthe public and lend out part of these funds to those
coins are issued by the
17 is the only institution which c¡n issue currency notes. However,
India? (Choose the correct alternative)
18. Which of the following is not a function of the Reserve Bank of
(a) It issues the currency of the country.
(b) It acts as a bank to the banking system.
(c) It is the custodian of the foreign exchange reserves of the economy.
(d) None of the above
economy. Almost every country has one central bank. India got its
19. Central Bank is a very important institution in a modern (Fill in the blank)
central bank in 1935. Its name is
True/False? Give reason.
|20.Currency notes and coins are called fiat money. True/False? Give reason.
21. Currency notes and coins are called legal tenders. True/False? Give reason.
22. Demand deposits are called legal tenders.
 UNT2Money and Banking
True/False? Give reason.
23. Money supply is a stock variable. (Choose the correct alternative)
money.
24. Currency created by the Central Bank is called barnk
(CBSE 2015) (Choose the correct alternative)
25. Whoregulates money supply in India?
(a) Government of India
(b) Reserve Bank of India
(c) Commercial Banks
(d) Planning Commission
(Choose the correct alternative)
26. The components of money supply are:
(a) Currency held by the public
(b) demand deposits of the public in commercial banks
(c) other deposits with the RBI
banks
(d) currency held by the public and demand deposit of the public in commercial
27. Fixed deposit is also termed as:
(Choose the correct alternative)
(a) Chequeable deposits (b) Demand deposit
(c) Time deposit (d) Non-chequeable deposits

Money.Creation by CommerciaBankng System:

22 Worng of Money MuttplerLending rocessot Banks

Process of Money Creation by Commercial Banks

Commercial banks receive deposits from the public. The depositors are free to withdraw, in part or in full, their
deposit amounts by writing cheques. The banks use the money in these deposits to give loans. These functions
of the commercial banking system are the basis of money creation. Note that money creation is also called
deposit creation' or credit crcation'.
Commercial banks cannot use the totaldeposits for giving loans. It is legally compulsory for the banks to keep a
certain minimum fraction of net 1otal demand and time deposis as legal reserves. The fraction is called the Legal
Reserve Ratio (LRR).
LRR is the minimum reserve that a commercial bank must maintain as per the instructions of the central bank.

Top Tip
Legal Reserve Ratio is also called Reserve Ratio or Required Reserve Ratio or Reserve Deposit Ratio or Legal Reserve
Deposit Ratio.

The LRR is fixed by the Central Bank. It has two components:

(i) Cash reserve ratio (CRR): It is che fraction of net total demand and time deposits that commercial
banks must keep as cash reserves with the Central Bank.
Gi) Statutory liquidity ratio (SLR): It is che fraction of net total demand and time deposits that commercial
banks must keep with themselves in the form of specified liquid assets.
low much are the deposits created is determined by primary deposits and Legal Reserve Rario (LRR). Primary
deposits refer to initial deposits with the commercial banks.
Giyen the amount of primary deposits (or inicial deposits) and the legal reserve ratio (LRR), total deposits
ation (or credit creation or money creation) will be:
Total credit creation (or money creation) =Initial deposits x 1/Legal Reserve Ratio
 02 Dey
Macroeconomics XIL by Subhash

RECAP
Money creation by commercial banks
Money creation (or credit creation or deposit creation) is aprocess by which acommercial bank creates totl deposits number
of times the primary deposits. Primary deposits refer to initial deposits with the commercial banks.
Process of credit creation is based on the following assumptions:
(i) There is single banking system in the economy.
(i) Alltransactions are routed through banks.
Total credit creation= Initial deposits x 1/Legal Reserve Ratio
LRR 0s the minimum reserve that a commercial bank must maintain as per the instructions of the central bank.
Initially, customer deposits 10,000 and LRR is 20%. Bank keeps 2,000 as reserves to meet customers' obligations and give
loans of 8,000. Those who borrow willspend this money and same 8,000 will ultimately come back to bank as fresh
deposits.Out of these 8,000, bank keeps 20%, i.e. R1,600 as reserves and give loans of ?6,400. In this way, in every round
80% of loans are converted into fresh deposits.
Total deposits creation (or credit creation or money creation) =Initial deposits x1/LRR =10,000 x1/0.2 =10,000 x5 =50,000
Credit creation is inversely related to the legal reserve ratio.
For example, suppose LRR is O0.2 and initialdeposits are 10,000.
Totalcredit creation =Initial Deposits x 1/LRR =10,000x 1/0.2 =10,000 x5 =50,000
Now suppose, if the LRR is increased by the Central Bank to 0.5 and initial deposits remain the same, i.e. 10,000.
Now, total credit creation =Initial Deposits x 1/ LRR =10,000 x 1/0.5 =10,000 x 2 =*20,000.
Thus, any increase in LRR willdecrease the credit creation power of the commercial banks (banking system).
Credit creation is directly related to money multiplier.
Money Multiplier (or Credit Multiplier or Deposit Multiplier) is the number by which totaldeposits can increase due to agiven
change in deposits. Lower the money multiplier, lesser will be the total credit created and vice-versa.
Total credit creation = Initial deposits x Money Multipler (1/LRR)
For example, suppose the LRR is 0.2 and initial deposit is 10,000. Money multiplier = 1/LRR = 1/0.2 = 5; and Total credit
created =710,000x5 =750,000.
Whereas, suppose LRR is increased by the Central Bank to 0.5 and initial deposits remain the same, i.e. 10,000.
Then,Money multiplier =1/0.5 =2; and Total credit created =10,000 x2=20,000:
Thus, with the same initialdeposit total credit creation decreases with a decrease in the value of money multiplier.

Objective ype Ouestions 22

1. There is a limit to money or credit creation by banks, and this is determined by the central bank (RBI). The RBl decides a
certain percentage of (i)_ which every bank must keep as reserves, called (i). This is done to ensure that
no bank is 'Over lending'. (Fill in the blanks)
2. Since banks earn interest from loans they make,any bank would like to land the maximum possible. But there is a limit to
money or credit creation by banks and this is deternmined by (Fill in the blank)
3. Apart from the CRR, banks are also required to keep some reserves in liquid form in the short term. This ratio is called
(Fill in the blank)
4. Deposit creation by banks comes to an end when (Choose the correct alternative)
(a) fresh deposits with banks become zero (b) legal reserve ratio becomes zero
(c) money multiplier becomes zero (d) total reserves equal initial deposits
5. State, eiving reason, whether the following statement is true or false:
Higher the Legal Reserve Ratio (LRR),greater would be the money creation in the economy.
6. LRR and money creation has (Choose the correct alternative)
(a) positive relation (b) negative relation
(c) No relation (d) Both (a) and (b)
7. The value of credit multiplier willbe high when (Choose the correct alternative)
(a) Legal reserve ratio is high (b) Legal reserve ratio is low
(c) Legal reserve ratio is zero (d) Legal reserve ratio is infinity
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 AAMe

UNIT 2: Money and Banking 109

Additional NCERT Content Extracted from látestNCERT Bóok

POLICY TOOLS TO CONTROL MONEY SUPPLY
1. Change in Legal Reserve Ratio: If the Central bank increases the reserve ratio, this would lead to decrease in lending by the banks which,
in turn, would reduce the deposits and hence, the money supply.
2. Open Market Operations: Open Market Operations refers to buying and selling of bonds issued by the Government in the open market.
This purchase and sale is entr1sted to the Central bank on behalf of the Governrnent. When RBI buys a Government bond in the open
market, it pays for it by giving a cheque. This cheque increases the total amount of reserves in the econormy and thus increases the money
supply. Selling of abond by RBI(to private individuals or institutions) leads to reduction in quantity of reserves and hence the money supply.
There are two types of open market operations - outright and repo.
Outright open market operations are permanent in nature. When the central bank buys these securities (thus injecting money into the
system), it is without any promise to sell them later. Similarly, when the central bank sells these securities (thus withdrawing money from the
system), it is without any promise to buy them later. As a result, the injection/absorption of the money is of perroanent nature.
However, there is another type of operation in which when the central bank buys the security, this agreement of purchase also has
specification about date and price of resale of this security. This type of agreement is calleda repurchase agreement or repo, The interest
rate at which the money is lent in this way is called the repo rate. Similarly, instead of outright sale of securities the central bank may sell the
securities through an agreement which has a specification about the date and price at which it will be repurchased. This type of agreement
is calied areverse_ repurchase agreement or reverse repo. The rate at which the money is withdrawn in this manner is called the reverse
repo rate. The Reserve Bank of India conducts repo and reverse repo operations at various maturities: overnight, 7-day, 14- day, etc. This
type of operations have now become the main tool of monetary policy of the Reserve Bank of India.
3. Bank Rate: The RBIcan influence money supply by changing the rate at which it gives loans to the commercial banks. This rate is called the
Bank Rate in India. By increasing the bank rate, loans taken by commercial banks become more expensive; this reduces the reserves held
by the commercial bank and hence decreases money supply. A fall in the bank rate can increase the money supply.

Obective Type Questions2

1. The REI can influence money supply by changing the rate at which it gives loans to the commercial banks for long-term
periods. This rate is called the India. (Choose the correct alternative)
(a) Bank Rate (b) Repo Rate
(c) High powered money (d) Lending Rate
2. The central bank controls money supply of the country through various methods, like bank rate, open market operations
and variations in (Fill in the blank)
3 refers to buying and selling of bonds issued by the Government in the open market by the central bank on
behalf of the Government. (Fill in the blank)
4. Vhen RB! buys a Government bond in the open market, it the money supply in the economy. (increases/
decreases) (Fill in the blank with correct option)
5. When the central bank buys the government security through an agreement which has a specification about date and
price of resale of this security. This type of agreement is called a (i) The interest rate at which the money is lent
in this way is called the (ii) (Fill in the blanks)
6. When the Central bank sells the government security through an agreement which has a specification about the. date
and price at which it will be repurchased. This type of agreement is called a ())_ The rate at which the money is
wihdrawn in this manner is called the (i) (Fillin the blanks)
7. the RB! increases the bank rate, money supply in the econonny (increases/decreases)
(Fill in the blank with correct option)
8. Repo rate is the rate at which1 (CBSE 2017) (Choose the correct alternative)
(a) commercial banks purchase government securities from the central bank
(b) commercial banks can take loans from the central bank
(c) commercial banks can keep their deposits with the central bank
(d) short-term loans are given by commercial banks
9. The ratio of net total demand and time deposits that a commercial bank has to keep with Reserve Bank of India is called:
(CBSE 2017) (Choose the correct alternative)
(a) Statutory liquidity ratio (b) Deposit ratio
(c) Casth reserve ratio (d) Legal reserve ratio
 16. 13. 12. 11. 10.
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 Macroeconomics XITby Subhash Dey

GhedEs t0 bjeciye Iype Diiestions

Objective Type Questions 2.1 the LRR, lower would be the value of money multiplier
1. (c) Bank money and hence, money creation willbe less in the economy.
2. (d) Currency notes and coins 6. (b) negative relation
3. (d) 7. (b) Legal reserve ratio is low
Inter-bank deposits
4. (c) as on any point of time. Objective TypeQuestions 2.3
5. (b) Saving account deposits and current account deposits
6. (c) Both (a) and (b) 1. lender of last resort
7. d) All of the above 2. Qualitative; Quantitative
3. (a) - (), (b) - (i)
8. (i) savings, or current account deposits 4. (b) Central Bank
(ii) they are payable by the bank on demand from the 5. (a) Central Bank
account-holder. 6. (b) Cash Reserve Ratio
9. bank moncy 7. (c) Bankers' Bank
10. legal tenders
11. Time deposits Objective Type Questions 2.4
12. Only deposits of the public held by the banks are to be 1. (a) Bank Rate
incduded in money supply. The interbank deposits, which 2. Reserve ratios
a commercial bank holds in other commercial banks, are 3. Open Market Operations (OMO)
not to be regarded as part of money supply. 4. increases
13. Cash and bank deposits 5. () Repurchase agreement or Repo (i) Repo Rate
14. high powered money 6. (i) Reverse Repurchase Agreement or Reverse Repo
15. commercial banks (ii) Reverse Repo Rate
16. Commercial banks 7. decreases
17. The Reserve Bank of India (RBI): Government of India. 8. (b) commercial banks can take loans from the central bank
18. (d) None of the above 9. (c) Cash reserve ratio
19. The Reserve Bank of India (RBI) 10. (b) Margin Requirements
20. TruC: RBI is responsible for giving the bearer of the 11. (d) Reverse Repo Rate
currency equal purchasing power. 12. (6) Statutory Liquidity Ratio
21. True: They cannotbe refused by any citizen of the country 13. (d) Repo Rate
for settlement of any kind of transaction. 14. (c) Both (a) and (b)
22. False: Cheques drawn on savings or current accounts 15. (b) Money supply will decrease
can be refused by anyone as a mode of payment. Hence, 16. (c) Buying government securities
demand deposits are not legal tenders. 17. False: Statutory liquidity ratio is the ratio of net toral
23. True: Money supply is the total stock of money in demand and time deposits that commercial banks must
circulation among the public at a particular point of timne. keep with themselves in the form of specified liquid assets.
24. Falss: The currency created by the Central bank (Reserve 18. False: Reverse repo rate is the rate at which the Central
Bank of India in India) is called High Powered Money. Bank borrows funds from banks.
25. (b) Reserve Bank of India 19. True: Decrease in margin requirements nhances the
26. (d) currency held by the public and demand deposit of the borrowing capacity of public, which raises the money
public in commercial banks supply in the economy.
27. (c) Time deposit 20. (a) Margin Requirement
21. (d) Both (b) and (c)
Objective Type Questions 2.2 22. (a) Lower the bank rate and purchase of securities in the
1. () Net total demand and time deposits open market
(ii) Legal Reserve Ratio/Reserve Ratio 23. (a) Fall in bank rate
2. the central bank (RBI) 24. (c) Selling the government securities
3. Statutory Liquidity Ratio (SLR) 25. (b) Government securities should be sold
4. (d) total reserves equal initial deposits 26. (c) Purchase of government securities in the open market
5. False: Value of money multiplier is inversely related to 27. (c) Margin requirement
LRR since money mnultiplier = 1/LRR. Therefore, higher