Question

Without a central bank, commercial banks in Canada would probably hold ________ reserves than they do now, resulting in a ________ money supply than at present.

A) The same; the same
B) More; larger
C) More; smaller
D) Less; smaller
E) Less; larger

Answer 1

Without a central bank, Canadian commercial banks would hold more reserves, leading to a smaller money supply. The correct answer is C) More; smaller, because increased reserves lower banks' lending capacity and thus decrease the money supply.

Step-by-step explanation:

Without a central bank, commercial banks in Canada would probably hold more reserves than they do now, resulting in a smaller money supply than at present. The correct answer is C) More; smaller. In the absence of a central bank banks may increase their reserves as a precaution against uncertainty and potential bank runs, where depositors withdraw their funds en masse out of fear that the bank may fail.

Since banks make money by issuing loans, and the reserve requirement dictates how much money must be held back and not loaned out more reserves mean less capacity for lending. This, in turn would decrease the money available in the economy, leading to a smaller money supply.