If the ratio of currency to deposits (cr) increases, while the ratio of reserves to deposits (rr) is constant and the monetary base (B) is constant, then:
A) it cannot be determined whether the money supply increases or decreases.
B) the money supply increases.
C) the money supply decreases.
D) the money supply does not change.

Question

Quizplus · Accepted Answer

The money supply decreases because the money multiplier, which is 1 / (cr + rr), decreases when cr increases (assuming rr is constant). A higher currency to deposit ratio means more money is held as currency rather than deposited in banks, which reduces the base for banks to create additional money through lending.

If the Ratio of Currency to Deposits (Cr) Increases, While