Question

Suppose Canadian banks increase their desired reserve ratios from 10% to 20% of bank deposits. Holding everything else constant, this will Select one:

a. reduce the size of the money multiplier.

b. cause the banking system to contract the level of bank deposits in the banking system.

c. change the value of the money multiplier from 10 to 5.

d. Answers (a), (b), and (c) are all correct.

Answer 1

If desired reserve ratio increases from 10% to 20%, then money multiplier would reduce. This is because when more money is kept as reserve, less would be loaned out and hence the money mutiplier decreases.

Money multiplier= 1/ RR where RR is reserved ratio

MM(old)=1/10=10

MM(new)=1/20=5

So money multiplier reduces from 10 to 5.

Hence both option A) and C) would be correct.

Now this would also cause the banking system to contract as the loans and deposits reduce when more money is kept as reserve.

So answer would be option D) all a,b and c are correct.

(You can comment for doubts)