Question

Explain how an increase in the reserve requirement by the Federal Reserve can lead to a decrease in real GDP.

Answer 1

Ans) Reserve ratio ( CRR) is the percentage of reserves that a bank has to hold against deposits. Increasing the reserve requirement falls under the category of contractionary monetary policy and it reduces the liquidity and raises cost of credit which in turn makes the input cost of the company to increase and it also reduces demand , as the amount that the bank can lend is now reduced and to maintain their profit bank will increase their interest rate. Increased input cost and lowered demand will result in reduction of output.

All these factors result in decrease in real gdp ( measure of economic output adjusted to inflation).