Question

Evaluate both of the following statements as true or false and explain your reasoning.

    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.

Answer 1

A.

False

Monetary base = currency in circulation + RR*Deposit + excess reserve

As per the above equation, it is shown that the increase in excess reserve, can increase the monetary base. But, holding on to the excess reserve and not lending, inhibits the creation of money supply as new deposits are not being created. So, it cannot be said that increase in the monetary base, leads to increase in money supply as well.

B.

False

Money multiplier = 1/required reserve ratio

So, money multiplier is changed when required reserve ratio is changed and it is changed by the FED or central banks. Lending policies affect the criteria of lending and to whom the lending can be done.