Question

An increase in the reserve requirement 

A) increases the money supply by decreasing excess reserves and decreasing the monetary multiplier 

B) decreases the money supply by increasing excess reserves and decreasing the monetary multiplier 

c) decreases the money supply by decreasing excess reserves and decreasing the monetary multiplier 

D) increases the money supply by increasing excess reserves and increasing the monetary multiplier

When the federal government cuts taxes and increases purchases to stimulate the economy during a period of recession, such actions are designed to be 

A) expansionary 

B) contractionary 

C) passive 

D) automatic

Answer 1

Answer 1. Reserve requirement refers to the cash reserve and statutory liquidity reserve, that is legal reserve. Reserve requirement means, Bank are suppose to keep some cash with themselves, instead of lending everything to the public.

An increase in reserve requirement imposed by the Central Bank on the other banks, causes banks to keep more reserves with themselves rather then lending them the public. So, Increase in reserve requirement, causes decrease in money supply in the economy and multiplier values also decreases (Multiplier = 1/ Reserve Requirement).

So, the correct option is B, Decreases the money supply by increasing the excess reserves, and decreasing the multiplier.

Answer 2. If federal government cuts taxes, it helps the people by increasing their disposable income that is money they have for spending after deducting taxes. By increasing purchases, government is again infusing the money in the economy. These actions are expansionary in nature as they are expanding the money supply in the economy.