The paper "National Economic Policy" is a perfect example of a report on macro and microeconomics. Effects of the currency-deposit ratio and reserve-deposit ratio increase in the money supply of a closed economy. The currency-deposit ratio rely on household preferences, therefore, in a closed economy it cannot be directly controlled by the government, whereas the reserve-deposit ratio relies on bank policies and regulations. In this case, an increase in both the currency-deposit ratio and the reserve-deposit ratio will have a negative impact on the money supply. Reserve-deposit ratio increase due to banks' low reserve will lead to a lower money multiplier hence a decline in the money supply.
In addition, the currency-deposit ratio also increases due to households' preference to hold liquid cash, as s result money multiplier will be lowered hence a decline in the money supply. The increase in the currency-deposit ratio implies that money is being withdrawn from the banking system reducing the amount of money available to banks to lend out. The populace view bank deposits in a sub crisis situation to be risky. This is because banks are likely to fall during such a crisis.
Therefore, money creation by banks through money multiplier is limited, hence a fall in the money supply. An increase in the reserve-deposit ratio is negatively related to money multiplier and money supply. The reason is that it will lead to a reduction of money available to banks to lend. The banks in times of sub crisis view money lending as a risky adventure. This is because a considerable number of borrowers are likely to default their debt. During such times, banks prefer holding a high reserve-deposit ratio since they believe it is much safer.
The main effect of the two changes will be on the monetary base (MB), this is because of MB= Currency (Money held by the households) plus Reserves (money held by banks). The increase in currency-deposit and the reserve-deposit ratio will mean a decline in the monetary base. The money supply is, thus, given by the monetary base multiplied with the money multiplier.
Krugman, P., & Wells, R., 2009, Macroeconomics, London: Worth Publishers.
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