If the Reserve Bank of Australia (RBA) decides to raise the cash rate, the reserves will _______, the monetary base will _______, and the money supply will _______.
Question
If the Reserve Bank of Australia (RBA) decides to raise the cash rate, the reserves will _______, the monetary base will _______, and the money supply will _______.
Solution
If the Reserve Bank of Australia (RBA) decides to raise the cash rate, the reserves will decrease, the monetary base will decrease, and the money supply will decrease.
Explanation:
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Reserves will decrease: When the cash rate increases, it becomes more expensive for banks to borrow from the RBA. As a result, banks will try to reduce their borrowing from the RBA, leading to a decrease in reserves.
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Monetary base will decrease: The monetary base consists of currency in circulation and reserves. Since reserves are decreasing, the monetary base will also decrease.
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Money supply will decrease: When the cash rate increases, it becomes more expensive for banks to lend to each other and to consumers. This leads to a decrease in lending, which reduces the money supply. Additionally, higher interest rates can encourage people to save more and spend less, which also reduces the money supply.
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