Which one of the following statements is the most true?
A) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies an increased home money supply.
B) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies a decreased home money supply.
C) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies an increased home money demand.
D) If central banks are not sterilizing and the home country has a balance of payments surplus, any associated decrease in the home central bank's foreign asset implies an increased home money supply.
E) If central banks are not sterilizing and the home country has a balance of payments shortage, any associated decrease in the home central bank's foreign asset implies an increased home money supply.

Question

Quizplus · Accepted Answer

If central banks are not sterilizing, any increase in foreign assets will result in an increase in the home money supply. This is because the increase in foreign assets means an increase in the overall reserves of the central bank. As a result, the central bank will then have more money to lend out to banks and other financial institutions, which will in turn increase the overall money supply in the home country. If the home country has a balance of payments surplus, that means that more money is coming into the country than is leaving the country. This means that there is an excess supply of foreign currency, which the central bank might buy up. Since the central bank is not sterilizing, this increase in foreign assets will translate into an increase in the overall money supply.

Which One of the Following Statements Is the Most True