After the 2009 financial crisis, countries in the Basel Committee on Banking Supervision have agreed to raise the mandatory reserves for banks. Explain what happens to the money multiplier and the bank deposit multiplier if the reserve ratio is increased and what governments need to do if they wish to maintain the previous level of broad money M.
After the 2009 financial crisis, countries in the Basel Committee on Banking Supervision have agreed to raise the mandatory reserves for banks.
Explain what happens to the money multiplier and the bank deposit multiplier if the reserve ratio is increased and what governments need to do if they wish to maintain the previous level of broad money M.
The mandatory reserves for banks mean the required reserves that the commercial banks have to keep in the form of currency in the economy. When the mandatory reserves are increased, the commercial banks will have to keep more money or more percentage of the deposits with the central bank in the form of money. This reduces the size of deposits that the commercial banks can make use of to provide loans to the public.
The reduction in the amount that can be used to provide loan makes the multiplier to change. The multiplier is calculated by dividing the value 1 with the required reserve rate. Since the required reserves come in the denominator part of the multiplier, it causes the multiplier value to rise in the economy. Thus, a reduction in the money supply will have more multiplier times fall in the aggregate demand in the economy.
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