Question

Consider the U.S. banking system prior to October 2008. If there were no excess reserves in the banking system and the Fed lowered the required reserve ratio, it follows that banks would have:

a. More reserves available
b. Less reserves available
c. The same amount of reserves
d. Uncertain impact on reserves

Answer 1

The correct answer is option a. More reserves available.

Step-by-step explanation:

When the Federal Reserve lowers the required reserve ratio, banks are indeed allowed to hold a smaller amount in reserves. This means that banks will have more reserves available to lend out. Prior to October 2008, if there had been no excess reserves in the banking system, reducing the required reserve ratio would have increased the amount banks could lend out, thus encouraging the expansion of the money supply.

In the context of the question, by lowering the reserve ratio, the amount of reserves required to be held by banks decreases, which effectively increases the portion of deposits that banks can use for lending or investment purposes. This action by the Federal Reserve is a means of conducting monetary policy to stimulate economic activity by increasing the amount of money in circulation, hence banks would have more reserves available following a decrease in the required reserve ratio.