Understanding Key Money Ratios in Economics

In economics, particularly in the study of money and banking, several ratios are used to understand how money circulates within the economy and how the banking system functions. These ratios help us analyze the components of the money supply.

What is the Ratio of Public Currency to Bank Deposits?

The question asks about a specific ratio: the money held by the public in the form of currency (physical cash like notes and coins) compared to the money they hold in bank deposits (like savings accounts or current accounts).

This ratio is a measure of the public's preference for holding cash versus keeping their money in banks. It is formally known as the Currency Deposit Ratio (CDR).

Mathematically, the Currency Deposit Ratio is expressed as:

$$ \text{Currency Deposit Ratio (CDR)} = \frac{\text{Currency held by the public}}{\text{Deposits held by the public in banks}} $$

For example, if the public holds $100 billion in currency and has $500 billion in bank deposits, the CDR would be $100 billion / $500 billion = 0.2 or 20%.

Importance of Currency Deposit Ratio

The Currency Deposit Ratio is a crucial determinant of the money multiplier and, consequently, the overall money supply in an economy. A higher CDR means people hold more cash relative to deposits. This reduces the funds available with banks for lending, which in turn limits the process of credit creation and lowers the money multiplier.

Analyzing Other Banking Ratios

Let's look at the other options provided to understand why they are different from the Currency Deposit Ratio:

• Reserve Deposit Ratio: This is the ratio of the total reserves (cash held by banks + deposits held by banks with the central bank) that banks hold to their total deposits. It reflects the banking system's willingness or requirement to hold reserves.
• Cash Reserve Ratio (CRR): This is the fraction of net demand and time liabilities (deposits) that commercial banks must hold as reserves with the central bank (like the Reserve Bank of India). It is a tool used by the central bank to control liquidity in the banking system. CRR is a component of the Reserve Deposit Ratio.
• Statutory Liquidity Ratio (SLR): This is the fraction of net demand and time liabilities that commercial banks must maintain in the form of specified liquid assets, such as government securities, gold, and cash, within their own premises or with themselves. SLR is another tool used by the central bank and is also a component of the Reserve Deposit Ratio.

While CRR and SLR are ratios related to what banks must hold against deposits, the Currency Deposit Ratio is about the public's behaviour regarding how they divide their money holdings between physical cash and bank deposits.

Based on the definitions, the ratio of money held by the public in currency to that they hold in bank deposits is the Currency Deposit Ratio.

Revision Table: Comparing Key Ratios

Additional Information on Money Multiplier

The ability of the banking system to create money through the process of deposit creation is influenced by several factors, including the Currency Deposit Ratio (CDR) and the Reserve Deposit Ratio (RDR). The simple money multiplier formula is often given as $$ \frac{1}{\text{Reserve Ratio}} $$, but a more realistic multiplier considers both ratios: $$ \text{Money Multiplier} = \frac{1 + \text{CDR}}{\text{Reserve Ratio} + \text{CDR}} $$. This formula clearly shows that an increase in the Currency Deposit Ratio leads to a decrease in the money multiplier, thus reducing the total money supply created from a given injection of high-powered money.