The Impact of Bank Reserve-to-Bank Deposit Ratio on Monetary Base and Money Multiplier
What happens when the bank reserve-to-bank deposit ratio decreases?
A. The monetary base increases and the money multiplier increases
B. The monetary base remains unchanged and the money multiplier decreases
C. The monetary base decreases and the money multiplier remains unchanged
D. The monetary base remains unchanged and the money multiplier increases
E. The monetary base decreases and the money multiplier decreases
F. The monetary base remains unchanged and the money multiplier remains unchanged
G. The monetary base increases and the money multiplier remains unchanged
H. The monetary base increases and the money multiplier decreases
Answer:
The correct answer is A. The monetary base increases and the money multiplier increases.
When the bank reserve-to-bank deposit ratio decreases, it means that banks are holding a smaller portion of their deposits as reserves and are instead lending out more money. This has two effects on the monetary base and the money multiplier.
First, the decrease in the reserve-to-deposit ratio means that banks have more funds available to lend out. This increases the monetary base, which is the sum of currency in circulation and bank reserves held at the central bank. When banks lend out more money, it increases the amount of currency in circulation and therefore increases the monetary base.
Second, the decrease in the reserve-to-deposit ratio also affects the money multiplier. The money multiplier represents the relationship between the monetary base and the money supply. When banks hold more reserves, the money multiplier is smaller because they have less money available to lend out. However, when banks hold fewer reserves, the money multiplier increases because they can lend out more money for each dollar of reserves.
In summary, when the bank reserve-to-bank deposit ratio decreases, it causes the monetary base to increase because banks have more funds available to lend out. It also causes the money multiplier to increase because banks can lend out more money for each dollar of reserves.