Question

Everything else held constant, an increase in the excess reserves ratio causes the M1 money multiplier to ________ and the money supply to ________?

1) Increase, Increase
2) Increase, Decrease
3) Decrease, Increase
4) Decrease, Decrease

Answer 1

3)The increase in the excess reserves ratio leads to a decrease in the M1 money multiplier and a consequent decrease in the overall money supply.

Step-by-step explanation:

When there is an increase in the excess reserves ratio, also known as the reserve requirement, the M1 money multiplier will decrease, and as a consequence, the money supply in the economy will decrease. This is because the reserve requirement determines the percentage of deposits banks are required to keep on hand and not lend out.

When the reserve requirement is increased, banks have less capacity to create new money through lending since a greater proportion of deposits must be kept as reserves. Therefore, the correct answer to the question is: an increase in the excess reserves ratio causes the M1 money multiplier to decrease and the money supply to decrease.