Depository institutions (DIs) play an important role in the transmission of monetary policy from the central bank (Reserve Bank of Australia) to the rest of the economy primarily because:[Fill in the blank]

Question

BlackTom AI · Accepted Answer

DI deposits constitute a large share of the money supply, so changes in central bank policy quickly affect the quantity and cost of those deposits and therefore aggregate spending.

Relevant concepts: the monetary base (central bank reserves + currency), money supply aggregates (M1/M3 dominated by bank deposits), the money multiplier (deposit creation via fractional-reserve banking), and transmission channels (interest‑rate channel and credit/reserve channels). The RBA changes its policy rate (cash rate) which alters banks’ funding costs and reserves; banks then adjust lending and deposit rates and the willingness to extend credit, changing deposit balances in the economy.

Step‑by‑step reasoning:
1. The RBA changes the cash rate → short‑term market rates shift.
2. Banks’ funding costs and reserve conditions change, so banks raise or lower loan and deposit rates and the volume of lending.
3. When banks make loans, new deposits are typically created (deposit expansion). With fractional reserves, a single change in base money can generate a multiple change in deposits via the money multiplier.
4. Because deposits make up the bulk of M1/M2/M3, a change in banks’ lending or deposit behaviour significantly alters the measured money supply and thus aggregate demand.

Illustrative calculation: if required reserves = 10%, the simple money multiplier = 1/0.10 = 10. A central‑bank injection of base money $100 could ultimately support up to $1,000 in deposits. This shows deposits dominate the money stock and amplify central bank actions.

Why other choices are incorrect:
a. Loans to corporations are not themselves the primary counted component of the money supply (deposits are). 
c. While banks provide housing credit, that is a sectoral effect, not the primary reason monetary transmission is effective. 
d. Regulation of loans doesn’t explain why DIs transmit policy quickly.

Conclusion: therefore the correct answer is b. DI deposits are a major portion of the money supply.

Depository institutions (DIs) play an important role in the transmission of monetary policy from the central bank (Reserve Bank of Australia) to the rest of the economy primarily because:[Fill in the blank]Single choice

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