What is the Relation Between LRR and Money Multiplier?

By BYJU'S Exam Prep

Updated on: November 9th, 2023

LRR shares an inverse relationship with Money Multiplier. LRR stands for Legal Reserve Ratio which is the minimum fraction of deposits that the banks are mandated to keep as cash themselves. The ratio of ratios of commercial bank money to central bank money (also known as monetary base) is called Money Multiplier.

Relation Between LRR and Money Multiplier

The lower the LRR, the greater the money multiplier effect and the greater the money creation. The money multiplier is a phenomenon that occurs in the economy when money is created in the form of credit. Based on the fractional reserve banking system, money is created in the market. It is also known as a monetary multiplier or a credit multiplier.

The formula of the Money Multiplier is 1/LRR or 1/r = Money Multiplier,

where LRR denotes the legal reserve ratio. It is the minimum deposit ratio required by law for commercial banks to maintain between themselves and the Reserve Bank of India, also known as the RBI.

What is Money Multiplier?

The Money Multiplier is another name for the monetary multiplier. In layman’s terms, it is the multiple by which the banking system can convert deposits received in the form of base money into wide money. It explains how an increase in the monetary base increases the money supply by a multiplied amount.

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