Question

Explain the role of Cash Reserve Ratio in removing an inflationary gap

Answer 1

Cash Reserve Ratio (CRR) is the necessary minimum percentage of a bank’s total deposits which is to be kept with the Central Bank. Commercial banks need to maintain with the Central Bank a certain percentage of their deposits in the form of cash reserves. The Central Bank can vary CRR between 3% and 15%. When a bank holds a large portion of deposits as CRR, it reduces the provision of credits to the public. This leads to a decline in the demand for loans and  consumption expenditure. Thus, the aggregate demand reduces and the economy attains equilibrium.