If many people were to suddenly deposit into their checking accounts large sums of cash previously held in their homes and/or wallets, and there were no offsetting actions by the Fed or change in institutional policies, this would
A) decrease the M1 money supply but increase the M2 money supply.
B) increase the excess reserves of banks and expand the money supply if these reserves are used to make additional loans.
C) reduce the excess reserves of banks and indirectly decrease the M1 money supply.
D) reduce the excess reserves of banks and indirectly increase the M1 money supply.

Question

Quizplus · Accepted Answer

When people deposit cash into their checking accounts, it increases the reserves of banks, leading to an expansion of the money supply if those reserves are used to make new loans. This mechanism is known as the deposit multiplier effect. Therefore, if there were no offsetting actions by the Fed or change in institutional policies, the increase in deposits would increase the excess reserves of banks and expand the money supply if those reserves were used to make additional loans. This would be consistent with Choice B, which is the correct answer. Choice A is incorrect because an increase in deposits would increase both M1 and M2 money supplies. Choices C and D are incorrect because they assume that the deposit multiplier effect would not occur, but that would not be the case under the scenario described.

If Many People Were to Suddenly Deposit into Their Checking