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IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

In an economy, the public holds currency equal to 20% of deposits (c = 0.20) and banks hold total reserves equal to 10% of deposits (r = 0.10). Using the money multiplier (1 + c)/(c + r) for the ratio of money supply (currency plus deposits) to monetary base, what is the increase in money supply if the monetary base rises by Rs 300 crore?

The money supply rises by Rs 1,200 crore. The multiplier is (1 + 0.20) divided by (0.20 + 0.10), which is 4, and applying it to the Rs 300 crore rise in monetary base gives Rs 1,200 crore. Ignoring currency holdings would wrongly give Rs 3,000 crore.

  1. ARs 900 crore
  2. BRs 1,000 crore
  3. CRs 1,200 croreCorrect
  4. DRs 3,000 crore
  5. Rs 600 crore

Explanation

Multiplier = (1 + 0.20)/(0.20 + 0.10) = 1.2/0.3 = 4. Increase in money supply = 4 x 300 = Rs 1,200 crore. Rs 3,000 crore wrongly uses 1/r = 10, ignoring currency leakage.

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