d) Assume that the Kenyan economy is in a recession, how can the monetary authorities use...

d) Assume that the Kenyan economy is in a recession, how can the monetary authorities use the required reserve ratio to boost economic performance?
e) Explain how the action in ( d) will work.

Expert Solution

d) during recession any government wants to increase its spending and income. To achieve this the monetary authorities can lower the required reserve ratio.

e) The mechanics of a lower required reserve ratio are as follows. Required reserve ratio is the minimum percentage of deposits that all banks have to necessarily keep in liquid (cash) form to meet any unexpected demands. This means that this percentage of deposits does not go into credit creation and hence money supply.

When the monetary authority lowers this ratio it means that the banks have some extra cash with them now for lending purpose. Assuming this is actually lent then by the process of credit creation and money multiplier this will increase the money supply in the economy. This means that now people have more money to spend and hence they will demand more and thus the economy can be brought out of recession. Additionally more money supply would mean lower interest rates which would induce firma to invest to meet this growing demand and hence the overall economic performance will improve with supply and demand picking up.

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Rahul Sunny answered 2 years ago

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