WAEC Economics 2013 Theory — Question 12

Model answer

(a) The cash ratio is the minimum ratio between the cash reserves of commercial banks and their deposit liabilities to customers, prescribed by the Central Bank. A special deposit is additional cash that commercial banks are asked to deposit with the Central Bank when the minimum cash requirement is not enough to control money supply. (b) The cash reserve ratio is the ratio of the amount kept as reserve with the Central Bank to the total deposits, and it can be used to control money supply/aggregate demand indirectly. When government wants to reduce money supply, the Central Bank increases the reserve ratio so that commercial banks' ability to give loans is reduced; when government wants to increase aggregate demand, the Central Bank reduces the reserve requirement. Likewise, when there is inflation due to excess money supply, the Central Bank asks commercial banks for special deposit above the reserve requirement, to reduce aggregate demand, especially when there is inflation. (c) Instruments of fiscal policy include: Tax — government levies tax on people's income in order to control aggregate demand. Government spending — government increases its spending to raise aggregate demand and reduces its spending to reduce aggregate demand.