Page 166 - DECO402_Macro Economics

Unit-17: Money Multiplier and Credit Creation by Commercial Banks

y Money Multiplier: It is the ratio of change in money supply and change monetary base. Notes
y High Powered Money: It is that money which is issued by central bank or government and
is kept with themselves by the public or commercial banks.
y Credit Multiplier: It is the ratio between change in total deposit and change in primary
deposit.
y Demand Deposit: It is that amount kept by the people with the bank, which may be withdrawn
any time through cheque.
y Primary Deposits: Amount deposited as cash by the people in the bank is known as primary
deposit.
y Derivatives or Secondary Deposits: Derivative deposit is the result of primary deposit because
commercial banks, keeping a part of primary deposit in form of money, create secondary
deposit.
y Cash Reserve Ratio: That part of total deposit which commercial banks keep with themselves
as cash is known as cash reserve ratio.
y Excess Reserve: Cash reserve that remains with the bank in excess of cash reserve ratio is
known as excess reserve.
y Limitations of Credit Creation: (i) Cash reserve ratio: on cash reserve ratio being more, quantity
of credit creation redues. (ii) Amount of primary deposit: more primary deposit shows more
credit creation capacity (iii) Banking habit of the people: by more use of banking services by
people, more credit will be created. (iv) Credit policy of central bank: cheap credit policy of
central bannks provides the facility of more credit creation (v) Credit policy of other banks: is all
banks work united, more credit will be created (vi) Confidence of depositors (vii) Availability
of good borrowers (viii) Commercial and industrial conditions.
y Principle Parameters that Delimit the Credit Creation Capacity of Commercial Banks: (i)
cash reserve of commercial banks (ii) cash reserve ratio of central bank.

17.11 Summary
y Velocity of money should not be ignored. It means that how many times, one unit of money
(like a note or a coin) is used as a means of exchange. If velocity of money is measured in
form of per unit time-period or in form of flowing concept then, it will also be an important
determinant of money supply.

17.12 Keywords

y Discretion— Will.
y Non- Monetized— where there is no money.

17.13 Review Questions

1. What do you understand by money multiplier?
2. Describe the limitation of credit creation.
3. How does money get into the economy?
4. Does supply of money in the economy depend on the dicretion of the central bank?

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