Question

How do changes in the reserve requirement affect the money multiplier?

Select the correct answer below:

the money multiplier increases when the reserve requirement increases

the money multiplier decreases when the reserve requirement increases

the money multiplier decreases when the reserve requirement decreases

the money multiplier is not affected by changes in the reserve requirement

Answer 1

The money multiplier decreases when the reserve requirement increases

Money multiplier measures the amount of money that the banks are able to create in the form of deposits with every unit of money it keeps as reserves.

Money multiplier = 1 divided by Reserve requirement

The value of money multiplier is determined by reserve requirement. Higher the value of reserve requirement, lower the value of money multiplier and less money is created by the baking system. Therefore the money multipler decreases when reserve requirement increases.