A central bank raised the reserve requirement ratio from 5 percent to 8 percent. Other things the same, how does the money multiplier change?
A) It increases by 3.
B) It decreases by 3.
C) It increases by 7.5
D) It decreases by 7.5

Question

Quizplus · Accepted Answer

When the reserve requirement ratio is raised, banks can lend out less of their deposits, which decreases the money supply. The money multiplier is calculated as 1/reserve requirement ratio. Therefore, when the reserve requirement ratio increases from 5% to 8%, the money multiplier decreases from 20 to 12.5. This means that for every dollar of reserves held by the central bank, the money supply will only increase by $12.50, compared to the previous $20. Therefore, the correct choice is D as the money multiplier decreases by 7.5.

A Central Bank Raised the Reserve Requirement Ratio from 5