What must be true when banks hold excess reserves?
A) The money multiplier overestimates how much money will be created in the economy.
B) The money multiplier underestimates how much money will be created in the economy.
C) The reserve ratio is not fully functioning and should be raised.
D) The reserve ratio is working too well and should be lowered.

Question

Quizplus · Accepted Answer

When banks hold excess reserves, the money multiplier overestimates how much money will be created in the economy. This is because the money multiplier formula assumes that banks will loan out their excess reserves, thus increasing the money supply. However, if banks instead choose to hold onto their excess reserves, this will not happen and the money multiplier will overestimate the amount of money that will be created.

What Must Be True When Banks Hold Excess Reserves