Question

In Ramadan month and in Christmas, consumers increase their preferences for cash versus demand deposits. Explain the effect this has on

1-      Primary deposits

2-      Derivative deposits

3-      Credit multiplier

4-      Money multiplier

5-      Monetary base

6-      The money supply

Answer 1

1. Primary deposits- decrease.

As consumers liquidity preference increases, they keep their cash in hand rather than depositing it in the commercial banks. Thus primary deposits decrease.

2. Derivative deposits- decrease.

Derivative deposits consist of the proceeds of a loan credited to the depositor's account. Derivative depostis are created through primary deposits. Thus if primary deposits decrease, bank's ability to create derivative deposits (extending loans) also decreases.

3. Credit multiplier- lowers.

Credit multiplier refers to the level of credit created by the banks. Credit multiplier= Change in deposits/ change in reserves. Since the numerator (deposit) have decreased the value of credit multiplier also lowers.

4. Money multiplier- lowers.

The money multiplier is the amount of money that banks generate with each dollar of reserves. Similar to credit multiplier, money multiplier is also lowered.

5. Monetary base- unchanged.

A monetary base is the total amount of a currency that is either in general circulation in the hands of the public or in the commercial bank deposits held in the central bank's reserves. It remains unchanged.

6. Money supply- decreases.

Since the banks ability to lend and create credit decreases, the money supply in the economy also decreases.