Money Multiplier in India

RBI releases a lot of data on monetary aggregates on a weekly basis. Though, analysing monetary data is not in fashion anymore, it does throw long term trends. Take the case of money multiplier (MM).  It is a common measure mentioned in most text books. When it comes to practice or seeing research on monetary policy, you hardly find a mention. With this crisis we expect renewed focus on monetary variables etc. So, I thought to describe it a bit.

MM is the amount of money the banking system generates with each rupee of reserves. It works like this.

  • Say you deposit 100 Rs with a bank. Banks are required to maintain a percentage of deposits collected as cash reserves with central bank.
  • The central bank imposes this reserve on the bank to manage liquidity situation in an economy. In India we call this Cash reserve ratio (CRR).
  • So let us assume CRR is 10%. Then Bank deposits Rs 10 with RBI and lend the Rs 90 to another customer X.
  • X takes the loan and say buys a machinery from Y.  Y takes the payment and deposits the money in his bank.
  • The bank again gives the money for credit  after netting out the reserves. And the cycle goes on this manner. So 100 Rs of deposit with a bank leads to multiplies of the same amount. This is called money multiplier.

Now how to measure it?

  • It can be measured as: (1+c)/(c+r), where, c is currency-deposit ratio and r is reserve requirement ratio (CRR in India’s case).
  • Currency is currency held by the public for transactions and is given by RBI on a fortnight basis.
  • Deposits are measured as term deposits at banks and is also given by RBI on a fortnight basis.
  • Both currency and term deposits form part of the money supply.
  • We take the ratio of both as people keep part of money as currency and part as deposits. The relation between currency, term deposit and reserve ration gives us the money multiplier. A reduction in r leads to an increase in the money multiplier and vice versa.

The below graph shows the money multiplier in India from Apr-2008 to 9-April -10.

Between April 08-Aug-08, multiplier declined from 4.3 to 4.1 levels as RBI increased CRR from 7.5% to 9%.  This was a time of high liquidity and inflation was increasing. And RBI was tightening the policy. RBI increased CRR multiple times.

In Sep-08, the global crisis hit Indian economy and RBI started easing the policy rates sharply. In a series of steps, CRR was lowered to 5% by 30-Jan 09. This led to increase in money multiplier which increased to 4.8 levels by Apr-09. As economy picked up from Apr-09 levels, multiplier increased further to 4.9 levels in Oct-09.

As economy had stabilised, RBI started increasing policy rates. It raised CRR in Jan-10 policy to 5.75% in two stages. As a result, we start to see decline in multiplier. It was at 4.66 on 9-Apr-10. AS we expect CRR to rise further, MM should decline over the years.

If we compare this with other developed economies, we can see the difference. In US, UK etc money multiplier failed to pick up despite central banks easing policy. So they had to resort to unconventional monetary policy to increase flow of money in the economy.

Let’s hope to read more research on monetary variables in other economies after this crisis.

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20 Responses to “Money Multiplier in India”

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  8. unicon india Says:

    Money creation is the process by which new money is produced or issued. There are three ways to create money:

    * by manufacturing paper currency or metal coins,
    * through fractional reserve banking and lending by the banking system,
    * and by government policies such as quantitative easing.

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    Central banks measure the money supply, which shows the amount of money in existence at a given time. An unknown portion of the new money created is indicated by comparing these measurements on various dates. For example in the US, one of the various money supply measurements, called M2, grew from $286.6bn in January of 1959 to $8,327bn in May 2009.

  10. Sources and Deployments of Money Supply in India « Mostly Economics Says:

    […] Sources and Deployments of Money Supply in India By Amol Agrawal As I posted a while back, it is useful to look at money supply in various ways. I had looked at relationship between M1 and M3 and money multiplier. […]

  11. Vaidehi Dhamankar Says:

    Hi!
    Really liked your article on money multipier, specially the graph showing the past trend. Text books often make things unnecessarily complex.
    Thanx,
    Vaidehi.

  12. pavan Says:

    hi,
    i need to know what is the money multiplier in U.S.A presently. could any body help me

  13. Brajesh Says:

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  15. swat Says:

    Sir
    http://www.livemint.com/articles/2012/01/24220118/Is-CRR-a-liquidity-or-a-moneta.html
    I was reading this article of yours and then read about money multiplier on your blog. I had a doubt. In this mint article you said that even though moneymultiplier is increasing , still crr was reduced, which further increases the multiplier.
    Isnt it beneficial in the current economy state to increase the money multiplier?Thats what RBI did.

    Thanks a lot.

    • Amol Agrawal Says:

      Hi,

      Thanks for the comments.

      Let me quote directly from RBI’s report which said this:

      The deceleration in reserve money was led by a moderation in the demand for currency.Notwithstanding the sharp deceleration in reserve money growth, broad money supply growth has mostly remained above the indicative trajectory of the Reserve Bank (Chart IV.10).This is mainly on account of sharp growth in money multiplier and indicates a need to maintain a delicate balance between provision of liquidity and maintaining control thereupon to restrain inflation.

      RBI is worried over slowing growth for sure but its bigger worry has been inflation in recent years. It is only in Dec-11 that there was some relief from inflation as it touched 7.5%. Higher money multiplier could just ruin RBI’s inflation goals once again this year. This is a clear concern RBI makes in the above statement as well.

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  18. Teaching macroeconomics: The money multiplier | Michael Kevane Says:

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  19. Bishal Sengupta Says:

    Reblogged this on Finconomics for you! and commented:
    A more practical approach to understand monetary supply and money multiplier calculations.

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