Question

If reserves are scarce, how would the money supply M change (increase or decrease) and why (due to an increase, decrease, or no change in the monetary base B, in the reserve-deposit ratio rr, or in the currency-deposit ratio cr) if:

(a) the central bank conducts overnight repurchase operations.

(b) the central bank conducts overnight reverse repurchase operations.

(c) the central bank increases the required reserve-deposit ratio.

(d) an article reporting a significant surge in cases involving counterfeit currency becomes viral.

(e) all drugs are legalized.

Answer 1

a. It refers to purchase of securities by the Central Bank. An open market purchase of government securities by the Central Bank will increase money supply in the economy because of increase in the level of monetary base in the economy.

b. Reverse repurchase operations will reduce the level of money supply in the economy because of decrease in the level of mponey supply in the economy.

c. Increase in the required reserve ratio by the Central bank will reduce money supply in the economy because the amount of excess reserves that are loaned out decreases.

d. This will induce people to reduce their currency deposit ratio because of the fear of fake currency and increase in the use of digitized payment system. This reduces currency deposit ratio and thus increases the level of money supply in the economy.

e. If all the drugs are legalized, then people will increase their currency holdings and increase in currecny to deposit ratio will reduce the level of money supply in the economy.