In the nineteenth century when there were often bank runs caused by crop failures, banks would make relatively fewer loans and hold relatively more excess reserves. By itself, which of the following actions should the banks have done?
A)They should have increased both the money multiplier and the money supply.
B)They should have decreased the money multiplier and increased the money supply.
C)They should have increased the money multiplier and decreased the money supply.
D)They should have decreased both the money multiplier and the money supply.

Question

Quizplus · Accepted Answer

During bank runs caused by crop failures, banks should decrease both the money multiplier and the money supply. This is because the risk of default increases, and to cover the potential losses, banks should hold more excess reserves, which leads to a decrease in the money supply. Moreover, making relatively fewer loans and decreasing the money multiplier will reduce the likelihood of a bank run or a further decrease in the money supply.

In the Nineteenth Century When There Were Often Bank Runs