Bance Solida has, in the past, always operated with a reserve ratio of 25 percent. It has now been taken over by Gung-Ho Bank Which operates with a reserve ration of 12½ percent, Assuming that Banca Solida adopts the business practices of its new owner, What will be the effect on money supply in the country in which Banca Solida operates ?
Correct answer: A. Money supply will increase because Banca Solida will increase its loans
- A. Money supply will increase because Banca Solida will increase its loans
- B. The effect on money supply cannot be determined from the information given
- C. Money supply will decrease because the loans will have to be repaid
- D. Money supply will be unchanged because the central bank has made no policy changes
Explanation
Reducing the reserve ratio from 25 percent to 12.5 percent permits the bank to lend a larger fraction of its deposits, increasing the deposit multiplier and potential money supply. The change does not require a new central-bank policy action.
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