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Explain the complete formula for the money supply, and explain how changes in desired
reserves, excess reserves, the currency ratio, the nonborrowed base, and Bank of Canada lending
affect the money supply.
Answer: The formula is indicates that the money supply is the product of the multiplier times
the base. Increases in any of the multiplier components reduce the multiplier and the money
supply. Increases in the nonborrowed base and Bank of Canada lending to banks increase the
monetary base and the money supply.
Diff: 2 Type: SA Page Ref: 390 - 391
Skill: Recall
Objective List: 16.4 Utilize a simple model of multiple deposit creation, showing how the
central bank can control the level of deposits by setting the level of reserves
Explain what happens to the money multiplier and the money supply when depositor
behaviour causes c to increase with all other variables remaining the same.
Answer: An increase in c means that depositors are converting some of their chequable deposits
into currency. As shown before, chequable deposits undergo multiple expansion while currency
does not. Hence when chequable deposits are being converted into currency, there is a switch
from a component of the money supply that undergoes multiple expansion to one that does not.
The overall level of multiple expansion declines, and so must the multiplier and the money
supply.
Diff: 1 Type: SA Page Ref: 393 - 394
Skill: Recall
Objective List: 16.4 Utilize a simple model of multiple deposit creation, showing how the
central bank can control the level of deposits by setting the level of reserves
How do changes in the desired reserve ratio affect the money multiplier?
Answer: Students can show this in two ways:
a. The formula for the money multiplier is m =. Thus, an increase in the desired reserve
ratio r will increase the denominator leaving the numerator unchanged ceteris paribus and so the
money multiplier will fall. A decrease in the value of the desired reserve ratio will decrease the
denominator and so the money multiplier will rise.
b. When banks increase their holdings of reserves relative to chequable deposits, the banking
system in effect has fewer reserves to support chequable deposits, This means that given the
same level of MB, banks will reduce their loans causing a decline in the level of chequable
deposits and a decline in the money supply and the multiplier will fall. The opposite will happen
when banks decrease their holdings of reserves.
Diff: 2 Type: SA Page Ref: 392 - 393
Skill: Recall
Objective List: 16.4 Utilize a simple model of multiple deposit creation, showing how the
central bank can control the level of deposits by setting the level of reserves