Question

6) Which of the following is INCORRECT?

A) The currency owned by chartered banks is NOT included in the money supply.

B) When chartered banks retire outstanding loans, the supply of money is increased.

C) The net export effect may partially counteract an expansionary fiscal policy.

D) The central bank expands money supply by lowering target for overnight lending rate and/or buying securities

11. Which of the following is correct? When the Bank of Canada buys bonds on the open market, the money supply:

A) contracts and chartered bank reserves increase.

B) expands and chartered bank reserves decrease.

C) contracts and chartered bank reserves decrease.

D) expands and chartered bank reserves increase.

Answer 1

Question 6

A) A chartered bank is just like any other commercial bank which accepts deposits and makes loans. However, a chartered bank has to take permission from government to do business in financial services industry. Money supply refers to the total sum of money available to the public at any point of time. As the currency owned by commercial banks is included in money supply as it is the currency held by the public with the banks in the form of demand deposits, similarly the currency owned by Chartered banks IS ALSO INCLUDED in the money supply as the public can withdraw it as and when required just like it can withdraw from commercial banks.

So statement (A) is CORRECT.

(B) Retiring outstanding loans means repaying debts taken earlier.

When anyone takes a loan, it leads to an increase in the money supply in the economy as the person taking the loan has an extra amount of money with him which he can spend anywhere anytime, so new money in the form of credit gets created in the economy. But when the same person repays the loan, it leads to a decrease in the money supply in the economy as the extra purchasing power now ceases to exist. Similarly, when chartered banks retire outstanding loans, the supply of money is decreased and NOT INCREASED. So, this statement is INCORRECT.

(C) When an expansionary fiscal policy is implemeted, it means that government does more expenditure than the revenue it collects through taxes. This expansionary fiscal policy leads to a rightward shift of the aggregate demand curve and as a consequence the prices increase. When the prices of domestic goods increase, it leads to a fall in our exports as the domestic goods become relatively expensive and an increase in our imports as foreign goods become relatively cheaper. This leads to a fall in our net exports which is known as net export effect. The net export effect may partially counteract an expansionary fiscal policy as an expansionary fiscal policy leads to an increase in GDP while fall in net exports leads to a decrease in our GDP. Therefore the GDP does not increase by as much amount as should have increased due to an expansionary fiscal policy. So yes, net export effect may partially counteract an expansionary fiscal policy. So the given statement is CORRECT.

(D) Overnight lending rates refer to the interest rates at which banks lend or borrow funds from other banks in the overnight market. When the central bank lowers targets for overnight lending rates, it decreases the cost of borrowing for the banks and hence they borrow more and further lend more to the public which leads to an increase in the money supply in the economy.

Similarly, when the central bank buys securities, it buys the securities and pays for them in money which leads to an increase in the money supply in the economy. So, the given statement is CORRECT.

Therfore, statement (B) is incorrect while the other three statements are correct.