Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
It decreases the money multiplier and limits credit creation.
B
It increases the money multiplier and promotes credit creation.
C
It has no effect on the money multiplier or credit creation.
D
It decreases required reserves without affecting the money multiplier.
Understanding the Answer
Let's break down why this is correct
Answer
When banks are required to keep more money in reserves, they have less money available to lend out. This means that the money multiplier effect, which shows how much money can be created in the economy from a single deposit, becomes smaller. For example, if a bank has to keep 20% of deposits as reserves, it can only lend out 80% of each deposit. If the reserve requirement increases to 30%, then it can only lend out 70%, reducing the total amount of money that can be created from that initial deposit. As a result, when reserve requirements go up, credit creation in the banking system slows down, leading to less money being available for people and businesses to borrow.
Detailed Explanation
When banks must keep more money in reserve, they have less to lend out. Other options are incorrect because Some might think that needing more reserves means banks can lend more; It's a common mistake to think that changing reserves has no effect.
Key Concepts
required reserves
money multiplier effect
credit creation
Topic
Reserve Requirements and Money Creation
Difficulty
hard level question
Cognitive Level
understand
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