Question

All else equal, which of the following will cause the money supply to fall?

A. banks decide to hold keep the same

B. banks make more loans.

C. banks decide to hold more excess reserves relative to deposits.

D. banks decide to hold less excess reserves relative to deposits

Answer 1

Since total reserve= Excess reserve+ required reserve

Since money supply are changed by= money multiplier* change in the ( deposit)

Since bank keep fraction of deposit ( required reserve) and rest loaned out.

Hence when banks decide to hold more excess reserves relative to deposits, this will lead to fall in the money supply and all else equal. This is because when bank hold more excess reserves relative to deposits, then less reserve will be loanded out, so less money supply will be created.

Hence option c is the correct answer.