Which of the following statements regarding the money creation process in fractional reserve banking is correct?
A 、The reserve requirement is negatively related to the quantity of money created.
B 、The reserve requirement is positively related to the availability of credit.
C 、The money multiplier is unaffected by the reserve requirement.
In an effort to influence the economy, a central bank conducted open market activities by selling government bonds. This action implies that the central bank is most likely attempting to:
A、 contract the economy by reducing bank reserves.
B、 expand the economy through a lower policy interest rate.
C 、contract the economy through a lower policy interest rate.
A is correct. The amount of money that the banking system creates through fractional reserve banking is a function of the money multiplier, which is expressed as 1 divided by the reserve requirement. Therefore, the smaller the reserve requirement, the greater the money multiplier effect on money creation.
B is incorrect because the reserve requirement multiplied by the deposit amount results in the amount of asset reserve that the bank is required to hold relative to the deposit liability. The higher the reserve requirement, the lower the net amount of the deposit (equal to the total deposit amount less the amount of required reserve) available for lending.
C is incorrect because the money multiplier is expressed as 1 divided by the reserve requirement. A higher reserve requirement results in a lower money multiplier, whereas a lower reserve requirement results in a higher money multiplier.
A is correct. Selling government bonds results in a reduction of bank reserves and reduces their ability to lend, causing a decline in money growth through the multiplier mechanism and hence a contraction in the economy.
B is incorrect. Central bank selling of bonds is not expansionary.
C is incorrect. Central bank selling of bonds will reduce the money supply through its impact on bank reserves, which will result in a higher, not lower, interest rate.