Question

‘Reserve Ratio and Credit Creation are inversely related.’ Do you agree with the given statement? Justify your answer with a suitable numerical example.

Answer 1

Yes, there exists an inverse relation between Reserve Ratio and Credit Creation in the economy.

We know that:

Money Multiplier = `1/"Reserve Ratio"`

Credit Creation = Initial Deposits x Money Multiplier

Assuming that the value of initial deposits is ₹ 10,000 crore.

Reserve Ratio	Money Multiplier	Initial Deposits	Credit Creation (Initial Deposits x Money Multiplier)
10%	`1/0.1 = 10`	10,000	1,00,000
25%	`1/0.25 = 4`	10,000	40,000

From the above calculation, we can conclude that higher the reserve Ratio, lesser credit will be created by Commercial Banks in the economy.