Suppose for a hypothetical economy, reserve ratio changes from 20% to 25% and the value of primary deposits are Rs. 1,000 crore. Calculate the change in the amount of credit creation when reserve ratio changes from 20% to 25%.

Question

Accepted Answer

Calculation of change in credit creation:

Given:
Reserve Ratio changes from 20% to 25%
Primary Deposits = Rs. 1,000 crore

Before change (RR = 20%):
Money Multiplier = 1/0.20 = 5
Total Credit Created = 1,000 × 5 = Rs. 5,000 crore

After change (RR = 25%):
Money Multiplier = 1/0.25 = 4
Total Credit Created = 1,000 × 4 = Rs. 4,000 crore

Change in Credit Creation = 5,000 - 4,000 = Rs. 1,000 crore

The credit creation capacity reduces by Rs. 1,000 crore when reserve ratio increases from 20% to 25%.