GED Social Studies TestEconomicsMedium
A country's central bank decides to raise the reserve requirement for commercial banks. Which of the following is the most likely immediate effect of this action?
- AA decrease in the amount of money banks can lend
- BAn increase in the money supply
- CAn increase in consumer spending
- DA decrease in interest rates
Show answer & explanationAnswer & explanation
Correct answer: A. A decrease in the amount of money banks can lend
Raising the reserve requirement means commercial banks must hold a larger percentage of their deposits in reserve, leaving less money available for lending. This directly reduces the amount of money banks can create through loans.
Why the other options are wrong
- B. An increase in the reserve requirement *decreases* the money supply, as banks have less to lend.
- C. A decrease in lending and potentially higher interest rates would likely *decrease* consumer spending, not increase it.
- D. A decrease in the amount banks can lend typically leads to *higher* interest rates, as money becomes scarcer.
Reserve Requirement
The fraction of deposits that banks are required by law to hold in reserve, rather than lend out. It is a tool of monetary policy used by central banks.
- Set by the central bank
- Impacts the money supply directly
- Higher requirement means less money available for lending
Memory trick: OMO is open, Discount is direct, Reserve is required.