Lower Reserve Ratio
The question
As part of a review of its banking rules, the central bank of Brennick lowers the fraction of deposits that commercial banks are required to hold as reserves. Assume the price level and real income are unchanged. Show the short-run effect of this action on the money market. Show the effect on the Money Market graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Lower Reserve Ratio: the worked answer
On the Money Market graph, Money supply (MS) shifts right.
Why Money supply (MS) shifts right
A lower required reserve ratio frees up reserves that banks previously had to hold idle and raises the money multiplier, which equals one divided by the required reserve ratio. Banks can extend more loans, and each new loan creates new deposits, so the total quantity of money is larger at every interest rate and the vertical MS line shifts to the right. Nothing in the stem changes the price level, real income, or the way households make payments, so money demand stays put.
What happens to the equilibrium
The equilibrium nominal interest rate falls as the quantity of money in the economy increases.
The mistake students make on this one
Students shift MS left here because the stem says something is being reduced and they map the word onto a leftward shift. What got smaller is the fraction of each deposit banks must hold idle, and a smaller required ratio means a larger multiplier and more deposit creation, so the money supply grows.
On exam day
Run every reserve-ratio stem through the multiplier, one divided by the required reserve ratio: a smaller ratio means a bigger multiplier, more deposit creation, and MS shifting right.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Money supply (MS) shifts right and every other curve on the Money Market graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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