Final answer:
The increase in the reserve requirement ratio from 5 percent to 8 percent decreases the money multiplier from 20 to 12.5, limiting the amount of money banks can create through loans and deposits and reducing the money supply in the economy.
Step-by-step explanation:
When a central bank raises the reserve requirement ratio, it directly affects the money multiplier process. The money multiplier is calculated as the reciprocal of the reserve requirement ratio. If the reserve requirement increases from 5 percent (0.05) to 8 percent (0.08), the money multiplier would decrease because banks are now required to hold more reserves compared to what they would lend out.
How the Money Multiplier Changes:
Previously, with a 5 percent reserve requirement, the money multiplier was 1 divided by 0.05, which is 20. After the increase to an 8 percent reserve requirement, the new money multiplier is 1 divided by 0.08, which is 12.5. Thus, the money multiplier decreases.
This decrease in the money multiplier means that for every dollar of reserves, banks will now create less money through loans and deposits than they could with a lower reserve requirement. The overall effect is a reduction in the supply of money circulating in the economy which helps contain inflation but can also slow down economic growth.