Raising the reserve requirement affects the money supply in what way?

• A. Higher inflation later
• B. More money to loan
• C. No effect on lending
• D. Less money to loan

Answer: (D)

Raising the reserve requirement tightens monetary conditions by forcing banks to hold more of their deposits as reserves. With a larger portion of funds tied up in reserves, banks have less excess reserves available to lend. Since a big part of money creation comes from banks issuing loans and the subsequent deposit expansion, reducing the amount they can lend lowers the money multiplier and the overall money supply. So, the correct idea is that there is less money to loan. This action would not increase lending, and it does affect lending by restricting it; it’s also a move that tends to slow inflation rather than spur it.