Final answer:
The decrease in excess reserves relative to bank deposits will lead to a weakened money supply multiplier. This is due to the reduced ability of banks to make loans, which in turn limits the creation of deposits and circulation of money through the banking system.
Step-by-step explanation:
If the economy is experiencing a decrease in excess reserves relative to the level of bank deposits, the effect on the money supply multiplier will not be to make it twice as strong or remain unchanged. Instead, the money supply multiplier will likely decrease, meaning it will be weakened (option 4).
This is because the money supply multiplier is based on the proportion of reserves that banks have available to lend out. When banks have fewer excess reserves, they have less ability to make loans, which in turn reduces the potential for deposit creation through the banking system.
In essence, with fewer loans made, the process of money being 'multiplied' as it is spent and re-deposited in banks is diminished.
The money multiplier is a core concept in understanding how bank lending affects the overall supply of money in an economy. Should banks hold higher reserves due to macroeconomic conditions or strict government rules, the quantity of loans they can issue is reduced, which can have a dampening effect on the money supply.
In more technical terms, the money multiplier can be represented as 1/reserve ratio. When banks hold more reserves (whether due to increased Federal Reserve requirements or a choice to hold extra reserves), the reserve ratio increases, leading to a smaller money multiplier effect.