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IIIustratewith thethe help of anhypothetical numericalexapmle the process of creditcreation |
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Answer» Solution :The money (or deposit or credit) CREATION by the commercial BANKS is determined by the amount of initialdeposit and the legalreserve ratio (LRR). Suppose the amount of initial depositis₹10,000 and LRR is 0.20. The bankswillkeep20% i.e ₹ 2,000 as reserve and lend the remaining ₹ 8,000 Those who borrow, will spend this money.‘lt is assumed that₹ 8,000 comes backtothe banks.This raises total deposits to ₹18,00. Banksagain KEEP 20% of ₹ 8,000, i.e, ₹ 1,600 as reserve and lend ₹ 6,400. This further raises the amount of deposits with the banks. in this way, deposits goon increasing @ 80% of the last deposit. The number of times, the total deposits will BECOME, is determined by the deposit or money multiplier: `"Money Multiplier"=(1)/(LR R)=(1)/(0.2)=5` The total deposits will be: `"initial deposit" xx "Money Multiplier" = 10,000 xx 5 = r 50,000`. |
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