Question

Suppose the Federal Reserve raised the reserve requirement. This would have the effect of

A.Decreasing the money supply and decreasing interest rates

B.Increasing the money supply and decreasing interest rates

C.Decreasing the money supply and increasing interest rates

D.Increasing the money supply and increasing interest rates

Answer 1

Option C

C.Decreasing the money supply and increasing interest rates

A reserve requirement is a fraction of amount of deposit banks needs to keep as reserves as per Fed guidelines.

An increase in the reserve requirement decreases the money supply

Money supply = monetary base *multiplier

Multiplier =1/reserve ratio

so the reserve ratio decreases and the money supply decreases.

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A decrease in the money supply shifts the money supply curve to the left which increases the interest rate in the economy.