Education | What effect does a change in the reserve requirement ratio have on the money supply?
Description: The reserve ratio is an important tool of the monetary policy of an economy and plays an essential role in regulating the money supply. When the. Had the minimum reserve ratio in Country A been set at , i.e., if the bank had been required to hold $ in its vault for every $1 on deposit in a bank account, . Explanation of how reserve requirement ratio changes affect the money stock. does a change in the reserve requirement ratio have on the money supply?.
Decreasing the ratios leaves depositories initially with excess reserves, which can induce an expansion of bank credit and deposit levels and a decline in interest rates. Thus, even a small change in the reserve requirement ratio may have a relatively large effect on reserve requirements and the money stock.
Few Changes in Reserve Requirements There are several reasons why reserve requirements are not frequently changed, the most important of which is that open market operations provide a much more precise tool for implementing monetary policy.
The impact of changes in reserve requirements is difficult to estimate; each change has the potential to affect thousands of depository institutions in different ways, depending on each institution's deposit base.
Changes in reserve requirements also typically lead to changes in pricing schedules for some bank services, because some bank fees and credits are set based on reserve requirements. The third monetary policy tool is the discount rate, the interest rate charged when depository institutions borrow overnight from the Federal Reserve discount window.
The Monetary Control Act of sets the statutory requirements for reserves. Net transaction accounts include checking accounts demand depositsNOW accounts, and share drafts. In a fractional reserve system, banks are only required to hold reserves against a fraction of their deposits.
Money Supply and the Money Multiplier
For additional detail, see the H. Although banks decide how much excess reserves they will hold, the central bank can influence that decision by the amount of interest that it pays on the reserves.Bank Required Reserve Ratio and Money Supply Problems
What isn't under the central banks' control is the public's demand for currency, but it can be influenced by interest rates. Any increased demand for currency will probably cause the money supply to contract because withdrawing money as currency reduces reserves, which, because of the multiplier effect, will reduce the money supply by more than the amount withdrawn.
- What effect does a change in the reserve requirement ratio have on the money supply?
- Money Supply and the Money Multiplier
- Economics Part A
When many banks failed during the Great Depression, many people withdrew most or all their money from the banks because they lost confidence in the banks, thereby worsening the Depression.
Of course, there is a multiplier effect even with currency, if it is used in multiple transactions as currency, but, during hard times, such as the Great Depression or during the recent Credit Crisis, people and businesses hoard cash to protect themselves in an uncertain environment and future.
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