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What happens when the central bank raises the reserve requirement?

Practice Questions

Q1
What happens when the central bank raises the reserve requirement?
  1. Banks can lend more money
  2. Money supply decreases
  3. Inflation increases
  4. Interest rates decrease

Questions & Step-by-Step Solutions

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.
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