Question

If you decide to hold $100 less cash than usual and therefore deposit $100 more cash in the bank, what effect will this have on checkable deposits in the banking system if the rest of the public keeps its holdings of currency constant?

Answer 1

Depositing $100 more into the bank instead of holding it as cash increases checkable deposits and has the potential to increase the M1 money supply through the banking multiplier effect.

Step-by-step explanation:

If you decide to hold $100 less in cash and instead deposit it into a bank, you effectively increase the checkable deposits in the banking system by $100.

The amount of money in the M1 money supply remains unchanged because the $100 is moving from one component of M1 (currency in circulation) to another (checkable deposits).

However, this action could potentially increase the overall money supply due to the banking multiplier effect.When you deposit money into a bank, the bank can use the majority of this deposit to make loans.

This action of loaning out money creates new deposits in the bank, which increases the amount of checkable deposits and thus increases the M1 money supply.

For example, if the reserve ratio is 10%, the bank can loan out up to 90% of the deposit, meaning that a $100 deposit can potentially lead to a $900 increase in checkable deposits due to multiple rounds of lending and depositing.