Question

As Computer Hacking become more prevalent now even in the financial system, if people cautiously began to hold larger than normal quantities of currency as protection against a possible disruption of banking services that could result from computer glitches or hacking.

1. How did this greater preference for currency affect the money supply?
2. How could the Federal Reserve offset such an increase in currency preferences?

Answer 1

i) Higher preference for the currency will increase the currency drainage ratio, which will reduce or decrease the money multplier. Also as the money multiplier falls, the money supply in the economy also will increase.

ii) Generally, fed can offset the decrease in the money multiplier caused by the higher preference for the currency by decreasing the rate of discount. Lower discount rate will increase the credit lending activity of the commercial banks, which will increase the overall money supply. The lower the discount rate, the more will be the fed can offset the fall in the money supply due to the currency drainage by a rise in the credit lending.