kalpeshjain
New member
CRR AND INFLATION
CRR (Cash Reserve Ratio) the amount of money that a bank must maintain as deposit with the central bank of the country (which is Reserve Bank of India in the case of India), before it can lend out any to individuals or corporations or any other customer. That means, Suppose one were to deposit Rs. 100 in the bank tomorrow. And the CRR is 8%. The bank where one has deposited the money will keep aside Rs. 8 for the central bank. So it can lend out the remaining Rs. 92. But that's not the end. The banks are further allowed to reason this way: If the borrower of Rs. 94 decides to give out the money to somebody, that somebody may deposit the amount with the bank. So the bank can lend out an extra Rs. 84.64 (Rs. 92 - 8% of Rs. 92). Effect of change in CRR to the money supply situation is that if the CRR is decreased to say 5% the amount of money that the banks can lend is increased to 20 times. While if the CRR is increased to say 10% the amount of money that the banks can lend is decreased to 10. Thus when the central bank feels that the banks will not be able to handle the credit scenario that is there is too much money in the system, it will increase the CRR and vice-a-versa. Although the central bank does not do this always. Sometimes it tries to use money market instruments such as treasury bills, bonds, repo rates and reverse repo rates, etc.
Effect of change in CRR on the credit situation (where the inflation part fits in)
Due to this increase in CRR, the ability of banks to lend money goes down. Now banks are also companies and they need to show profit for their business. So keep their profit up, they increase the lending rate which essentially decreases the availability of cheap loans. As the cost of loans go up, you and I tend to spend less on frivolous purchases or at the least try to keep them at the minimum. Thus demand of goods goes down in general. And as you know, the price of a good is driven by demand in a free market economy without price controls. So the prices go down. Consequently inflation goes down.
CRR (Cash Reserve Ratio) the amount of money that a bank must maintain as deposit with the central bank of the country (which is Reserve Bank of India in the case of India), before it can lend out any to individuals or corporations or any other customer. That means, Suppose one were to deposit Rs. 100 in the bank tomorrow. And the CRR is 8%. The bank where one has deposited the money will keep aside Rs. 8 for the central bank. So it can lend out the remaining Rs. 92. But that's not the end. The banks are further allowed to reason this way: If the borrower of Rs. 94 decides to give out the money to somebody, that somebody may deposit the amount with the bank. So the bank can lend out an extra Rs. 84.64 (Rs. 92 - 8% of Rs. 92). Effect of change in CRR to the money supply situation is that if the CRR is decreased to say 5% the amount of money that the banks can lend is increased to 20 times. While if the CRR is increased to say 10% the amount of money that the banks can lend is decreased to 10. Thus when the central bank feels that the banks will not be able to handle the credit scenario that is there is too much money in the system, it will increase the CRR and vice-a-versa. Although the central bank does not do this always. Sometimes it tries to use money market instruments such as treasury bills, bonds, repo rates and reverse repo rates, etc.
Effect of change in CRR on the credit situation (where the inflation part fits in)
Due to this increase in CRR, the ability of banks to lend money goes down. Now banks are also companies and they need to show profit for their business. So keep their profit up, they increase the lending rate which essentially decreases the availability of cheap loans. As the cost of loans go up, you and I tend to spend less on frivolous purchases or at the least try to keep them at the minimum. Thus demand of goods goes down in general. And as you know, the price of a good is driven by demand in a free market economy without price controls. So the prices go down. Consequently inflation goes down.
