Evaluate and Explain both of the following statements. A.) \"If banks increase t
ID: 1155976 • Letter: E
Question
Evaluate and Explain both of the following statements.A.) "If banks increase their excess reserves, the monetary base will increase. If the monetary base increases, the money supply will increase. Therefore, an increase in excess reserves increases the money supply”.
B.) The most important factor accounting for changes in the money supply, in the long run, is changes in bank lending policies that affect the money multiplier. Evaluate and Explain both of the following statements.
A.) "If banks increase their excess reserves, the monetary base will increase. If the monetary base increases, the money supply will increase. Therefore, an increase in excess reserves increases the money supply”.
B.) The most important factor accounting for changes in the money supply, in the long run, is changes in bank lending policies that affect the money multiplier. Evaluate and Explain both of the following statements.
A.) "If banks increase their excess reserves, the monetary base will increase. If the monetary base increases, the money supply will increase. Therefore, an increase in excess reserves increases the money supply”.
B.) The most important factor accounting for changes in the money supply, in the long run, is changes in bank lending policies that affect the money multiplier.
Explanation / Answer
A.) Excess reserves are those reserves that are kept by the banks over and above the bank reserves to back the chequable deposits. An increase in the excess reserves will restrain the growth of the money supply. The banks are left with less money that could be lent out. So the monetary base does not increase and hence the money supply do not rise.
B.) Money Supply = Monetary Base × Money Multiplier.
The above equation can be stated as Money supply is a multiple of Monetary Base. Monetary policy tools such as open market operations, reserve ratio, discount rate affect the bank's lending policies which inturn affect the money multiplier in the long run. For example: A lower discount rate enables a bank to pay less interest rate to the central bank which increases the liquidity of money. Similarly a higher reserve ratio means that banks needs to keep aside a higher part of deposits and due to which banks are left with a lesser portion which can be lent. These monetary tools affect the money multiplier which also affects the money supply.
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