Question

An increase in the reserve requirement ;

a.   increases the money multiplier and reduces the money supply.

b.   increases the money multiplier and increases the money supply.

c.   reduces the money multiplier and reduces the money supply.

d.   none of these.

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Which of the following policies by the Federal Reserve is likely to decrease the money supply?

a.   Reducing reserve requirements.

b.   Decreasing the discount rate.

c.   Selling government bonds.

d.   None of these.

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Suppose that a five-year Treasury bond pays 2.5 percent and a five-year corporate bond pays 8.5 percent, then what is the interest rate spread on this particular corporate bond?

a.   6 percent.

b.   7.5 percent.

c.   5 percent.

d.   9.0 percent.

Answer 1

(1) Money multiplier = (1 / reserve requirement)

An increase in reserve requirement will decrease the money multiplier. A decrease in money multiplier will reduce the money supply.

Answer: Option (C)

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(2) Central government use contractionary monetary policy to decrease the money supply in an economy:

Following are the tools of contractionary monetary policy.

• increase reserve requirement ratio
• increase discount rate
• selling government bonds

Answer: Option (C)

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(3) Interest rate spread on the particular corporate bond = 8.5% - 2.5%

Interest rate spread on the particular corporate bond = 6%

Answer: Option (a)