Question

1. What are reserve requirements? What happens to the money supply when a central bank raises reserve requirements?

2. Why don’t banks hold 100 percent reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates?

Answer 1

Reserve Requirements- It is a central bank regulation, which determines the amount should be kept by the commercial bank. It is kept by the commercial bank to meet the liabilities, in case of sudden withdrawals. It is a tool used by central bank to regulate the mopney supply in the economy.

Central bank can reduce the money supply in the economy by raising the reserve requirements and can increase the money supply in the economy by reducing the reserve requirements.