Question

Suppose that last year \(30 billion in new loans were extended by banks while \)50 billion in old loans were paid off by borrowers. What happened to the money supply?

1. Increased.

2. Decreased.

3. Stayed the same.

Short answer

Option (b) Decreased

Step-by-step solution

Explanation

While $30 billion were injected into the economy through loans, the money supply increased by $30 billion. However, the banks received back $50 billion as payback from borrowers. Thus, $50 billion were sucked from the money supply. So, the net effect is negative by $20 billion; $20 billion are in the bank reserves. Therefore, the money supply decreased.