Question

1. The money supply decreases if

1. Households decide to hold relatively more currency and relatively fewer deposits and banks decides to make less excess reserves and make more loans
2. Households decide to hold relatively less currency and relatively more deposits and banks decide to hold relatively more excess reserves and make fewer loans
3. Households decide to hold relatively less currency and relatively more deposits and banks decide to hold relatively less excess reserves and make more loans
4. Households decide to hold relatively more currency and relatively fewer deposits and banks decide to hold relatively more excess reserves and make fewer loans

Answer 1

Option D

• The federal reserve uses Expansionary monetary policy to either increase or decrease the money supply in the Economy.
• When it sells government securities in the open markets, the money supply decreases in the Economy, which will decrease the inflation rate and increase the interest rates.
• When the inflation rate is low, households and individuals wish to hold more money in their hands and keep their deposits low in the banks.
• The banks are also affected due to the decrease in money Supply, when the money supply declines in the Economy, the reserves in banks will also decline if they lend out more money to households and firms.
• Therefore when there is a decline in money Supply in the Economy, the bank will reduce their lending of loans and will increase their holding of excess reserves.