Consider a simple economy where money consists only of bank deposits and banks’ only assets are reserves and loans. Assume that banks wish to hold reserves in a desired proportion to deposits. In this kind of economy, Group of answer choices if the quantity of loans depends on the level of activity in the economy then the quantity of deposits and hence the quantity of money are endogenous the quantity of money will depend positively on the quantity of loans made by banks the quantity of money will be a multiple of bank reserves where the size of that multiple is larger the larger is banks’ desired reserves to deposits ratio both the first and second alternatives above are correct but the third alternative is incorrect.
Question
Consider a simple economy where money consists only of bank deposits and banks’ only assets are reserves and loans. Assume that banks wish to hold reserves in a desired proportion to deposits. In this kind of economy, Group of answer choices
if the quantity of loans depends on the level of activity in the economy then the quantity of deposits and hence the quantity of money are endogenous
the quantity of money will depend positively on the quantity of loans made by banks
the quantity of money will be a multiple of bank reserves where the size of that multiple is larger the larger is banks’ desired reserves to deposits ratio
both the first and second alternatives above are correct but the third alternative is incorrect.
Solution
The correct answer is: both the first and second alternatives above are correct but the third alternative is incorrect.
Here's why:
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If the quantity of loans depends on the level of activity in the economy then the quantity of deposits and hence the quantity of money are endogenous: This is correct. In this economy, if the level of economic activity increases, businesses and individuals will likely take out more loans. These loans increase the amount of deposits in the bank, which in turn increases the quantity of money in the economy. Therefore, the quantity of money is endogenous, or determined within the system.
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The quantity of money will depend positively on the quantity of loans made by banks: This is also correct. As banks make more loans, the quantity of deposits increases. Since deposits are the only form of money in this economy, the quantity of money increases as well.
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The quantity of money will be a multiple of bank reserves where the size of that multiple is larger the larger is banks’ desired reserves to deposits ratio: This is incorrect. In this economy, the quantity of money is not determined by the amount of bank reserves, but by the amount of loans made by banks. Therefore, the size of the multiple is not relevant in this case.
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