Question

3. We studied how the Reserve Bank of Australia (RBA) can influence the money supply in the Australian financial market. Answer each question briefly.

a) How does the open market operations increase the number of dollars in circulation?

b) How does the reserve ratio influence the money supply?

c) What do you think happens to the money multiplier (M) in a financial crisis and what is the likely impact of change in M to the economy?

Answer 1

a) A purchase of securities through open market operations injects the money in the economy which leads to increase in money supply and Vice Versa

b) Increase in reserve ratio requires banks to keep a larger share of their deposits as reserves which prevents them from lending more money to the public which consequently results in the lower money supply. And, Decrease in reserve ratio leads to increase in the money supply.

c) Money multiplier decreases in a Financial Crisis. Lower money multiplier would lower down the growth of the economy.