Question

If the Federal Reserve increases the interest rate paid on reserves, banks will tend to hold _____ excess reserves, which will _____ the money multiplier.
a. more; increase
b. more; decrease
c. fewer; increase
d. fewer; decrease

Answer 1

Answer:

Option (b) is correct.

Explanation:

If the federal reserve increases the interest rate on the bank deposits at Fed then as a result the banks will tend to hold more excess reserves as it will be more profitable for them to hold more reserves at Federal reserve.

If the amount of reserves increases then as a result the money multiplier falls.

Money multiplier = 1/ Reserve requirement ratio

Hence, an increase in the reserves will lead to decreases money multiplier.