Final answer:
Holding more excess reserves leads to a contraction in the money supply due to decreased lending. This can reduce economic growth by limiting money circulation but may be influenced by central bank actions long term.
Step-by-step explanation:
When banks decide to hold more excess reserves, which are reserves over the legally mandated limit, there is a contraction in the money supply. This is because the funds that could be used for creating loans are instead being held back by banks. This behavior is often observed during periods of economic uncertainty, such as a recession, where banks might be concerned about the creditworthiness of borrowers due to a higher risk of default. The reluctance to lend will lead to a reduction in the expansionary monetary policy's effectiveness, which aims to increase the supply of money and the quantity of loans in the economy.
Therefore, instead of causing fluctuations in the money supply, holding more excess reserves will most likely lead to a reduction in the money supply. This can have a ripple effect on economic growth because less money is being circulated. However, the impact also depends on the actions of the central bank. In the long term, cautious actions taken by central banks, keeping in mind the potential for economic instability, may lead to adjustments in monetary policy to compensate for the reduction in loanable funds.