Reserve Requirement Change
The question
Concerned about rising inflation, the central bank of Orlin raises the reserve requirement that commercial banks must hold against deposits. Show the short-run effect of this action on the money market, assuming all else is held constant. 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.
Reserve Requirement Change: the worked answer
On the Money Market graph, Money supply (MS) shifts left.
Why Money supply (MS) shifts left
A higher reserve requirement forces banks to hold a larger fraction of deposits as reserves, which reduces the money multiplier and the volume of loans banks can create. The total money supply contracts, so the vertical MS line shifts to the left. Money demand stays put because households' transaction needs have not changed.
What happens to the equilibrium
The equilibrium nominal interest rate rises as the quantity of money in the economy decreases.
The mistake students make on this one
Many students shift MD left instead, reasoning that "banks are now required to hold more money." A reserve requirement limits how much money the banking system can create, which is the quantity in existence, not how much money households and firms want to hold at each interest rate.
On exam day
The reserve requirement, the discount rate, and open-market operations are all central bank tools, so every one of them moves MS and none of them moves MD.
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 left 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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