Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
It decreases liquidity by requiring banks to hold more reserves.
B
It increases liquidity by allowing banks to lend more money based on reserves.
C
It has no effect on liquidity in the banking system.
D
It restricts liquidity by limiting the amount of money available for loans.
Understanding the Answer
Let's break down why this is correct
Answer
The money multiplier effect shows how banks can create more money in the economy based on the reserves they hold. When a bank receives deposits, it must keep a certain percentage as reserves, which is determined by reserve requirements. The rest can be loaned out, and when borrowers spend that money, it gets deposited in other banks, which can then lend out a portion again. This cycle continues, allowing a small initial deposit to lead to a much larger increase in the total money supply. For example, if a bank has a reserve requirement of 10% and receives a $100 deposit, it can lend out $90, which might be deposited again, leading to even more loans and creating more money overall.
Detailed Explanation
The money multiplier effect helps banks lend more money. Other options are incorrect because Some might think that holding more reserves means less money to lend; It's a common mistake to think that the money multiplier has no impact.
Key Concepts
money multiplier effect
liquidity
Topic
Reserve Requirements and Money Creation
Difficulty
medium level question
Cognitive Level
understand
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