Ravi deposits Rs 1,000 of currency, which he was holding at home, in his savings account in a bank. The Cash Reserve Ratio is 20 per cent, banks keep no extra reserves and every loan comes back to the banks as a deposit. Other things remain the same. What is the final change in M1?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → M1 rises by Rs 4,000.
M1 = CU + DD. Track both parts after the deposit and after the loans that follow.
At the moment of the deposit, currency with the public falls by Rs 1,000 and demand deposits rise by Rs 1,000. M1 does not change yet.
Then the Rs 1,000 becomes bank reserves. With a CRR of 20 per cent, the money multiplier is 1 ÷ 0.2 = 5.
Final rise in deposits = 1,000 × 5 = Rs 5,000
Change in M1 = −1,000 (CU) + 5,000 (DD) = Rs 4,000
Rs 5,000 counts only the rise in deposits and forgets the fall in currency with the public.
NCERT (2026-27): “3.3 MONEY CREATION BY BANKING SYSTEM … Another asset that a bank has is reserves. Reserves are deposits which commercial banks keep with the Central bank, Reserve Bank of India (RBI) and its cash.” “3.3.2 Limits to Credit Creation and Money Multiplier … Since the bank is only expected to keep 20 per cent of its deposits as reserves, thus, reserves of Rs 100 (20per cent of 500 = 100) can support the deposits of Rs 500. In other words, our bank can give a loan of Rs 400. Table 3.3 demonstrates its balance sheet.” “Legal Definitions: Narrow and Broad Money … M1 = CU + DD |