What happens when the central bank raises the reserve requirement?

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Question: What happens when the central bank raises the reserve requirement?

Options:

Correct Answer: Money supply decreases

Solution:

Raising the reserve requirement means banks must hold more reserves, leading to a decrease in the money supply.

What happens when the central bank raises the reserve requirement?

What happens when the central bank raises the reserve requirement?

Step 1: The central bank decides to raise the reserve requirement, which is the amount of money banks must keep on hand and not lend out.
Step 2: Banks now have to hold more money in reserve and cannot use it to give out loans.
Step 3: With less money available for loans, banks lend out less money to people and businesses.
Step 4: When banks lend less money, there is less money circulating in the economy.
Step 5: As a result, the overall money supply in the economy decreases.

Reserve Requirement – The minimum amount of reserves a bank must hold against deposits, which affects the bank's ability to create loans.
Money Supply – The total amount of money available in the economy, which can be influenced by central bank policies.
Central Bank Policy – Actions taken by a central bank to control the money supply and interest rates in the economy.