Question

Due to the market expectations about increasing inflation and in order to increase liquidity in the banking industry, the Fed decides to increase required reserve ratio to 15%. At the same time the Fed decrease the actual supply by 1,000 million dollars. What is the change in total trading cash volume in this economy

Answer 1

According to the question the Fed has taken a decision to increase the required reserve ratio to 15% in order to control the expected increase in the inflation. Required reserve ratio is a certain proportion of the total deposits of the commercial banks that are kept with the central bank as reserves.

Now, when the required reserve ratio increases that means larger proportion needs to be kept with the central bank which reduces the credit creation process as the bank would not be able to lend as much as before. The commercial banks would lend loans of lesser amount or probably would not lend any loan depending on the remaining deposits left in a bank after submitting the reserve to the central bank.

As per question, the Fed has also decreased the actual money supply by 1000 million dollars. We know that when the required reserve ratio is increased the money supply in the economy decreases. So, overall there would decrease in the money supply more than 1000 million dollars. The prices of the commodities would start to reduce. The inflation in the economy would reduce. But this situation might lead to deflation depending on the total decrease in the money supply in the economy.

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