Question

Suppose the reserve requirement is 10%.

a. If the Federal Reserve decreases the reserve requirement, banks can lend out:

A. fewer reserves, thus decreasing the money multiplier and decreasing the money supply.
B. more reserves, thus increasing the money multiplier and increasing the money supply.
C. fewer reserves, thus increasing the money multiplier and increasing the money supply.
D. more reserves, thus decreasing the money multiplier and decreasing the money supply.

b. The Federal Reserve:

A. rarely changes the reserve requirement and does not use the reserve requirement as a major monetary policy tool.
B. needs permission from the president before making changes to the reserve requirement.
C. does not have the ability to change the reserve requirement since banks determine the amount of reserves to lend.
D. changes the reserve requirement frequently in order to make adjustments to the money supply.

Answer 1

1)

B. more reserves, thus increasing the money multiplier and increasing the money supply.

In a fractional-reserve banking system, banks create money when they make loans. The more money they have available to make loans, the more money they create.

If the Fed reduces the reserve-requirements, banks will have more reserves available to loan out, increasing the money multiplier, and thus, the money supply.

2)

A. rarely changes the reserve requirement and does not use the reserve requirement as a major monetary policy tool.

The Fed rarely uses this monetary policy tool because it is the most powerful one. Changing the reserve requirements effectively reduce or increase the money supply like no other monetary policy tool, therefore, the effects can be dramatic, and its use is a sign that all other tools have been exhausted (open-market operations, and discount window mainly).

Step-by-step explanation: