Skip to content

IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy

Banks in an economy become more cautious and choose to hold a much larger share of deposits as excess reserves, while the central bank's monetary base is unchanged. What is the likely effect?

The money multiplier falls and broad money contracts. When banks hold more excess reserves, a smaller share of reserves is lent and redeposited, so each unit of monetary base supports fewer deposits, even though the central bank has not changed the monetary base.

  1. AThe money multiplier rises and broad money expands
  2. BThe money multiplier falls and broad money contractsCorrect
  3. CThe monetary base falls automatically
  4. DBroad money is unaffected because the base is unchanged
  5. Velocity of money must fall to exactly zero

Explanation

Higher excess reserves mean less of each reserve unit is lent out, so the multiplier falls. With the base fixed, broad money contracts. The base is set by the central bank, so it does not change by itself.

Did you get it right without looking?

One question tells you little. A timed set on Role of money and interest rates in the economy shows your real accuracy, how long you take and where you lose marks.

Practise Role of money and interest rates in the economyFree diagnostic mock

More Role of money and interest rates in the economy questions