Question

4. Required reserve ratio

If the Fed decreases the required reserve ratio, banks have to hold (more or fewer) reserves and thus the size of the money multiplier (decreases or increases) .

Which of the following explain why the required reserve ratio is becoming a less useful tool in the conduct of monetary policy? Check all that apply.

1.Popularity of ATMs forces banks to hold on more cash.

2.Demand for money has fallen over time.

3.Popularity of ATMs reduces the cash reserves at most banks.

4.Sweep accounts reduce balances on the checking accounts.

Answer 1

Required reserve ratio is a proportion of bank deposits which commercial banks are required to keep with themselves and not lend out. It is regulated by the central bank of the country.

The money multiplier of the economy depends upon this ratio and is given by:

m = 1/ rr

where m = money multiplier and

rr = required reserve ratio

Thus, if the Fed decreases the required reserve ratio, banks have to hold fewer reserves and thus the size of the money multiplier increases.

However, the required reserve ratio is becoming a less useful tool to conduct the monetary policy nowadays. This is because presence of digital mode of payments, and thus sweep accounts, reduces the balance on checking accounts and it becomes difficult to comply with the changing bank deposits and reserve requirements.

Ans. (D)