Question

*You read a story reporting a major scandal about the Federal Deposit Insurance Corporation that is likely to undermine the public’s confidence in the banking system. What impact, if any, do you think this scandal might have on the relationship between the monetary base and the money supply?

Answer 1

Answer:

Because the Federal Deposit Insurance Corporation is supposed to provide insurance to depositors in case of bank failure, a major scandal regarding this institution could affect both the monetary base and the money supply.

People, after learning about the scandal, would likely go to the bank and withdraw as much money as possible, possibly causing bank runs.

If the banks have less deposits to loan out, they will create less money, causing the money supply to grow less, or even, to contract.

As for the monetary base, if people withdraw money, they will hold more cash and less deposits. The monetary base is equal to currency in hands of the public plus bank reserves. A preference for cash would increase the currency element of the monetary base.