Part 1The money multiplier declined significantly during the period 1930-1933 and also during the recent financial crisis of 2008-2010. Yet the M1 money supply decreased by 25% in the Depression period but increased by more than 20% during the recent financial crisis. What explains the difference in outcomes? A. There was a significant increase in the monetary base during the recent financial crisis. B. There was a minimal increase in the currency ratio during the recent financial crisis. C. The overall level of deposit expansion decreased during the recent financial crisis. D. The excess reserves ratio increased rapidly during the recent financial crisis.

Question

Part 1The money multiplier declined significantly during the period​ 1930-1933 and also during the recent financial crisis of​ 2008-2010. Yet the M1 money supply decreased by​ 25% in the Depression period but increased by more than​ 20% during the recent financial crisis. What explains the difference in​ outcomes? A. There was a significant increase in the monetary base during the recent financial crisis. B. There was a minimal increase in the currency ratio during the recent financial crisis. C. The overall level of deposit expansion decreased during the recent financial crisis. D. The excess reserves ratio increased rapidly during the recent financial crisis.

BlackTom AI · Accepted Answer

Question restatement: The prompt compares the money multiplier’s behavior during 1930-1933 and the 2008-2010 financial crisis. It notes that M1 fell in the Depression, yet rose by more than 20% during the recent crisis, and asks what explains this difference in outcomes. Answer options are:
A. There was a significant increase in the monetary base during the recent financial crisis.
B. There was a minimal increase in the currency ratio during the recent financial crisis.
C. The overall level of deposit expansion decreased during the recent financial crisis.
D. The excess reserves ratio increased rapidly during the recent financial crisis.

Option A analysis:
This choice highlights the role of the monetary base. During the 2008-2010 crisis, the Federal Reserve expanded the base through quantitative easing and other methods. A larger monetary base can support higher M1 even if the money multiplier is not high, because more base money is available to be converted into deposits and currency. The observed rise in M1 aligns with a substantially increased monetary base, offsetting any drag from a lower multiplier.

Option B analysis:
If the currency ratio (currency per unit of deposits) rose only slightly, this would not fully account for a strong rise in M1, since a moderate or small increase in currency relative to deposits would still limit growth in the money supply. In practice, the crisis featured substantial base expansion and liquidity provision, so a minimal change in the currency ratio alone is unlikely to explain a large M1 expansion.

Option C analysis:
A decline in overall deposit expansion during the crisis would tend to curb M1 growth. However, the data show that M1 increased despite wide-scale monetary easing, implying that deposit growth alone did not drive the outcome downward. This option conflicts with the observed rise in M1 when the base was expanded aggressively.

Option D analysis:
An early, rapid rise in the excess reserves ratio would slow the money multiplier, potentially limiting money creation from the base. While excess reserves did rise during the crisis, this factor by itself does not explain a strong increase in M1; instead, it would dampen multiplier effects. The key driver for boosting M1 was the expanded monetary base, not the rapid growth of excess reserves alone.

Synthesis across options:
- The most consistent explanation for why M1 rose during the 2008-2010 period, despite a smaller multiplier, is the substantial expansion of the monetary base by the Fed. This base expansion supplied more funds into the banking system and economy, enabling greater money creation even if the multiplier did not rise.
- The other options either misstate the dynamics of currency ratios, deposit growth, or excess reserves relative to the observed outcome, or fail to capture the primary mechanism driving M1 up in that crisis period.

In summary, evaluating the mechanisms, the large scale up of the monetary base during the recent financial crisis stands out as the explanatory factor aligning with the observed rise in M1, whereas the remaining options describe changes that would attenuate or are inconsistent with the reported outcome.

Homework:Chapter 17 Homework

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