Question

Describe how the Federal Reserve controls the amount of money created in the banking system by changing the reserve requirements.

Answer 1

The monetary base is the amount of money in circulation in the system.

Money multiplier = 1/reserve ratio

The money supply = Money multiplier * Deposits

By decreasing the reserve ratio, the money multiplier is increased. Thus increasing the money supply in the system.

By increasing the reserve ratio, the money multiplier is decreased. Thus decreasing the money supply in the system.

This is how the Federal Reserve controls the amount of money created in the banking system by changing the reserve requirements.

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