Cambridge International as and a level Economics Ebook

government securities
to change bank lending. 
If the central bank wants to reduce bank loans it will sell 
government securities. Th
e purchasers will pay by drawing 
on their deposits in commercial banks and so cause the 
commercial banks’ liquid assets to fall.
Liquidity ratio: 
the proportion of a bank’s assets held in 
liquid form.
Government securities: 
bills and bonds issued by the 
government to raise money.
KEY TERMS
TOP TIP
In explaining the credit multiplier, it is useful to give a 
simple numerical example.
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Cambridge International A Level Economics

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SELF-ASSESSMENT TASK 
9.17
A bank keeps a liquidity ratio of 4%. It receives an 
additional cash deposit of $50,000. Calculate:
a
the credit multiplier
b
the potential increase in total liabilities (deposits)
c
the potential increase in bank lending.
Government spending financed by 
borrowing from commercial banks and the 
central bank
If the government spends more than it raises in taxation, 
it will have to borrow. If it borrows by selling government 
securities, including National Savings certifi cates, to the 
non-bank private sector (non-bank fi rms and the general 
public) it will be using existing money. Th
e purchases will 
be likely to draw money out of their bank deposits. So the 
rise in liquid assets resulting from increased government 
spending will be matched by an equal fall in liquid assets as 
money is withdrawn.
However, if a budget defi cit is fi nanced by borrowing 
from commercial banks or the central bank, the money 
supply will increase. When a government borrows from 
the central bank it spends money drawn on the bank. Th
is 
spending increases commercial banks’ liquid assets, which 
will increase their ability to lend. Commercial banks will 
also be able to lend more if the government borrows from 
them by selling them short-term government securities. 
Th
is is because these securities count as liquid assets and so 
can be used as the basis for loans.