Money and the banking system

Uncertainty regarding general business conditions will cause banks to hold excess reserves. Assuming that other things are constant, this action will: (a)Have no effect on the money supply. (b)Tend to reduce the money supply. ©Tend to increase the money supply. (d)Tend to reduce the money supply during a period of inflation and increase it under recessionary conditions. PS: I do understand the multiplier effect.


It might be obvious , for me was not. I thought the money supply was the prerogative of the Feds, not a direct result of bank’s action of holding excess reserves. I forgot “Tend”:slight_smile:

Is it B? My ration was as banks hold excess reserves, less money is available for lending.

B As the bank holds excess reserves less credit is created in the economy. The money multiplier effect kicks in though in the reverse gear thus reducing overall monetary supply. As an example the Chinese Central Bank has been increasing statutory reserve requirements thus decreasing monetary supply. Hence holding everything else constant it tends to reduce monetary supply.

I didn’t know that about the Chinese bank but the scuttlebutt is that increasing the rerserve requirement is a potent way of reducing the money supply, rarely used because of its potency and unpredictability.

In this case it is a voluntary decision made by banks not to extend their excess reserves. Thus, the money supply reduces. Something similar has been happening since August '07, with banks unsure about general business conditions the interbank lending has almost dried up. The consequence of this is unusually high interbank lending rate. I personally find amazing how we are able do draw parallels between CFA readings and the problems the real world is facing right now. Speaks volumes about the quality of this program.

this would have the same effect as if the fed increased the required reserve ratio

is this a level 1 question

yes sunnyday Wrote: ------------------------------------------------------- > is this a level 1 question