How Does an Increase in Currency-to-Bank Deposit Ratio Affect the Monetary Base and Money Multiplier?

What happens when the currency-to-bank deposit ratio increases, holding everything else constant?

Suppose the currency-to-bank deposit ratio increases. Everything else is held constant, this will cause the monetary base to _____ and the money multiplier to _____.

Select one: A. remain unchanged; decrease B. remain unchanged; increase C. increase; decrease D. increase; remain unchanged E. decrease; increase F. decrease; decrease G. increase; increase H. remain unchanged; remain unchanged I. decrease; remain unchanged

Answer:

Suppose the currency-to-bank deposit ratio increases. Everything else is held constant, this will cause the monetary base to remain unchanged and the money multiplier to decrease. The correct answer is option A) remain unchanged; decrease.

When the currency-to-bank deposit ratio increases, it means that more people are holding currency (cash) rather than depositing it in banks. This leads to a decrease in bank deposits, which in turn decreases the monetary base. The money multiplier, on the other hand, is the ratio of the money supply to the monetary base. When the currency-to-bank deposit ratio increases, the money multiplier decreases because there is less money being created through the fractional reserve banking system.

Decreasing the money multiplier means that the banking system creates less money for a given amount of reserves. This ultimately affects the overall money supply in the economy. It is essential to understand these relationships to analyze the impact of changes in the currency-to-bank deposit ratio on the monetary base and money multiplier.