See, Inflation is defined as a rise in the costs of good and services. Inflation is caused by an expanding economy when spending is high and the production of goods and services is not meeting demand.
So basically, there is a lot of money in the market and no goods to supply. What CRR or th Cash Reserve Ratio does is that the bank now has to hold back more money. If the reserve requirement is 10%, for example, a bank that receives a Rs. 100 deposit may lend out Rs. 90 of that deposit. If the borrower then writes a check to someone who deposits the Rs. 90, the bank receiving that deposit can lend out Rs. 81. As the process continues, the banking system can expand the change in excess reserves of Rs. 90 into a maximum of Rs. 900 of money (Rs. 90 Rs. 81 Rs. 72.90 ...=Rs.900). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial Rs. 100 deposit into a maximum of Rs. 500 (Rs.80 Rs.64 Rs.51.20 ...=Rs.500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.
