The money multiplier declined significantly during the period 1930-1933 and also during the recent financial crisis of 2008-2010. Yet the M1 money supply decreased by 25% in the Depression period but increased by more than 20% during the recent financial crisis. What explains the difference in outcomes? A. There was a minimal increase in the currency ratio during the recent financial crisis. B. The excess reserves ratio increased rapidly during the recent financial crisis. C. There was a significant increase in the monetary base during the recent financial crisis. D. The overall level of deposit expansion decreased during the recent financial crisis.

The correct answer is C. There was a significant increase in the monetary base during the recent financial crisis.

Explanation:

The Central Bank determines the monetary base and from there, financial intermediaries generate bank money.

If we see the composition of the balance of a Central Bank, the monetary base is equivalent to total assets less non-monetary liabilities.

If the monetary base increases: money creation

If the assets of the Central Bank increase (increase in foreign exchange reserves, increase in credit to the banking system or the public sector) without increasing non-monetary liabilities, it will logically have to increase the monetary liability (creation of money).

If non-monetary liabilities decrease, without variation of the asset, you will necessarily have to increase the monetary liability.