Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
It decreases liquidity, leading to less money creation.
B
It increases liquidity, allowing for more money creation.
C
It has no effect on liquidity or money creation.
D
It increases reserve holdings, thus decreasing liquidity.
Understanding the Answer
Let's break down why this is correct
Answer
In a fractional reserve banking system, banks are required to keep only a fraction of their deposits as reserves while they can lend out the rest. When reserve requirements are decreased, banks can hold less money in reserve and lend more to borrowers. This increase in lending boosts the amount of money circulating in the economy, which is known as liquidity. For example, if a bank has $100 in deposits and the reserve requirement drops from 10% to 5%, it can now lend out $95 instead of $90, creating more money for people to spend. Overall, lowering reserve requirements allows banks to create more money, which can stimulate economic activity.
Detailed Explanation
When reserve requirements go down, banks can keep less money in reserve. Other options are incorrect because Some might think that lowering reserves means banks have less money to lend; It may seem that changing reserve requirements has no impact.
Key Concepts
fractional reserve banking
liquidity
Topic
Reserve Requirements and Money Creation
Difficulty
medium level question
Cognitive Level
understand
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