other things equal, which of the following would increase the size of the real-w
ID: 1153569 • Letter: O
Question
other things equal, which of the following would increase the size of the real-world deposit multiplier? (C)
A. banks become skeptical of the ability of borrowers to repay loans
B. the required reserve ratio increases
C. banks choose to hold less excess reserves than before
D. the public holds on the to move currency than before
E.All of the above
The answer is C, please explain why. But I am confused that the answer C, cause hold less excess also mean required reserve increased, so RR will increase, then deposit multiplier (1/RR) will decrease. Or the answer C is mean that bank wants to make more loans by hold less excess reserves?
Explanation / Answer
Deposit multiplier is 1/RR.
The real deposit multiplier is less than the deposit multiplier because in deposit multiplier we assume that all excess reserves are loaned out and loan redeposited completely in the banking system
When banks hold excess reserves , the deposit multiplier will reduce because that money is not being loaned out , so it cannot be deposited. So real world deposit multiplier will reduce .
The formula of multiplier is
m= (1+ currency drain ratio )/(Currency drain ratio + desired reserve ratio)
we use this formula The currency drain ratio is the currency to deposit ratio whilke the desired reserve ratio is the sum of excess reserve ratio and required reserve ratio .
Now the question given to us states how will there be an increase the size of the real-world deposit multiplier
Out of the given options C is the correct one beacuse it states that the banks need to reduce the excess resrves. When banks reduce the excess reserves ,, that amount would be lend out to the public because all we need to keep is the required reserve ratio . Anything above it can be used by the banks to lend out so loans will increase . Once the banks lend out there will be more deposits as well . Holding less excess reserves does not imply holding more required reserve . The Required reserve ratio changes as per the central bank
And we know that the real world deposit multiplier is less than the deposit multiplier beacuse of presence of excess reserves and cash in hand with public . So this implies that the excess reserves are inversely related to real world deposit multiplier .
So for more real world deposit multilpier we need to reduce the excess reserves.
It cannot be option A beacuse in that case the bank instead of lending would keep the money as excess deposits and that will reduce the real world deposit multiplier.
It cannot be option B because if the required reserve ration increases the deposit multiplier reduces ie deposit multiplier is 1/RR
it cannot be option D because more currency in hand with the people would mean less deposits and less loans and so the real world deposit multilpier will reduce.
SO the answer is option C : banks will choose to hold less excess reserves than before
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