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When an ADI invests in a financial instrument issued by another ADI the stock of private money is not affected.

Question

When an ADI invests in a financial instrument issued by another ADI, the stock of private money is not affected.

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Solution

This statement is generally TRUE, but it depends on how the ADIs adjust their balance sheets. Here's a step-by-step explanation:

  1. An Authorized Deposit-taking Institution (ADI), or a bank, invests in a financial instrument (like a bond or a loan) issued by another ADI. This means the investing ADI is buying the financial instrument and giving money to the issuing ADI.

  2. The money used for this investment comes from the investing ADI's reserves, which are funds held at the central bank. This reduces the investing ADI's reserves but increases the issuing ADI's reserves. So, the total reserves (central bank money) remain the same, just their distribution changes.

  3. The stock of private money, which is the deposits in the ADIs, is not directly affected by this transaction. This is because the transaction is happening between the ADIs and doesn't involve the depositors' accounts.

  4. However, the stock of private money could change if the ADIs adjust their balance sheets in response to the transaction. For example, if the investing ADI reduces its loans or the issuing ADI increases its loans, the stock of private money will decrease or increase respectively. But if they adjust other items on their balance sheets, the stock of private money may remain unchanged.

  5. So, while the investment activity between ADIs doesn't directly affect the stock of private money, it could indirectly affect it depending on the specific actions of the ADIs.

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