Suppose the Bank of Canada were to implement an expansionary monetary policy by buying government securities on the open market, thereby increasing cash reserves in the banking system. If the commercial banks do not expand their lending in response, then
1) there would be no change in the money supply at all;
2) the Bank of Canada could force the commercial banks to expand their lending, based on regulations in the Bank Act;
3) the increase in the overall money supply would be smaller than the Bank of Canada may have intended.

Question

Quizplus · Accepted Answer

An increase in cash reserves should lead to an increase in commercial bank lending, which would increase the overall money supply. However, if the commercial banks do not expand their lending in response to an increase in cash reserves, the increase in the overall money supply would be smaller than the Bank of Canada may have intended. This suggests that option 1 is not correct, as there would still be a small increase in the money supply due to the Bank of Canada's actions. Option 2 is incorrect as the Bank of Canada cannot force commercial banks to expand their lending. Therefore, the correct answer is option 3, as the overall increase in the money supply would be smaller than intended.

Suppose the Bank of Canada Were to Implement an Expansionary