According to the monetary theory we have learned in this class, all else the same, which of the following events will cause the supply of money to increase, in both the scarce reserves and ample reserves eras?

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BlackTom AI · Accepted Answer

To tackle this question, we first identify the mechanism by which the monetary theory covered in class says the money supply expands. In both scarce reserves and ample reserves regimes, the key driver of a higher money supply is the creation of loans by banks, which creates new deposits and thereby increases the money supply.
Option 1: 'Households deposit their paychecks in their deposit accounts on paydays.' Deposits themselves reflect a shift of existing money from cash to deposits and do not by themselves create new money. While deposits affect the composition of money, they do not automatically expand the overall money supply without banks loaning out a portion of those deposits. Therefore, this action alone does not guarantee an increase in the money supply under either reserve regime.
Option 2: 'Some banks borrow from other banks in the federal funds market.' When banks borrow reserves from other banks, their reserve positions change, but the immediate effect on the overall money supply is not guaranteed. The Federal Funds borrowing is a balance sheet adjustment and may enable more lending, but it is not, by itself, the direct mechanism that creates additional money in the economy. Thus, this option is not the clearest or most direct cause of an increased money supply across both eras.
Option 3: 'Banks lend money to people to buy homes.' This is the classic mechanism of money creation. When banks issue new loans, they create deposits for the borrowers, which raises the total money supply. This process works regardless of whether reserve levels are scarce or ample, though the ease of lending may differ. Hence, this option correctly identifies the primary driver of money supply growth in both scenarios.
Option 4: 'People pay back their loans to the banks.' Repayment of loans reduces the amount of deposits in the system (and shrinks the money supply), since loan repayments remove previously created deposits from the banking system. This action decreases, rather than increases, the money supply in both reserve environments.
Option 5: 'None of the above' would be correct only if none of the listed options increased the money supply. Given that option 3 describes the standard loan-creation mechanism that expands deposits and the money supply, this option is not applicable.
In summary, the crucial distinction is that only new lending by banks directly increases the money supply by creating new deposits, while deposits, interbank borrowing, and loan repayments have more nuanced or opposite effects. The option that captures the core mechanism across both scarce and ample reserve contexts is the one describing banks lending to households. The other options either describe non-creating actions, or actions that reduce the money supply.

ECN 001B B01-B04 FQ 2025 Final Examination

According to the monetary theory we have learned in this class, all else the same, which of the following events will cause the supply of money to increase, in both the scarce reserves and ample reserves eras?

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