First note that the question comes out from Mankiw's intermediate macroeconomics textbook.

Question: The Fed increases the interest rate it pays banks for holding reserves. Explain how each of the following events affects the monetary base, the money multiplier, and the money supply.

Textbook Solution: It will cause the bank to have more money in reserve, which increase its reserve-deposit ratio, and cause a decrease in the money multiplier. And thus the money supply decreases. But the monetary base will increase because of the increase in reserve.

My wonderings: A decrease in money supply means a decrease in demand deposit. And hence the reserve-deposit ratio will drop as it is equal to $\frac{\text{Reserve}}{\text{Demand Deposit}}$.To keep the reserve ratio same, it will then have to decrease its reserve, which might offsets the increase in reserve before, maybe partially. So it is not at all certain whether the actual reserve has increased or not and thus not sure whether monetary base has increased or not.

Any answers or comments is appreciated.



Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Browse other questions tagged or ask your own question.