ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -If the Federal Reserve decides to lower the reserve ratio through an expansionary monetary policy, commercial banks are required to keep less cash on hand and are able to increase the number of loans to give consumers and businesses. This increases the money supply, economic growth and the rate of inflation.

Detailed explanation-2: -Conducting Open Market Operations Conversely, if the Fed wants to decrease the money supply, it sells bonds from its account, thus taking in cash and removing money from the economic system.

Detailed explanation-3: -To decrease the (growth of the) money supply, the Fed could either sell bonds, raise the reserve requirement ratio, or raise the discount rate.

Detailed explanation-4: -Discount Rate If the Fed wants to give banks more reserves, it can reduce the interest rate it charges, thereby inducing banks to borrow more. Alternatively, it can soak up reserves by raising its rate and persuading the banks to reduce borrowing.

Detailed explanation-5: -When the Fed increases the reserve requirement then it means the Fed is using a contractionary monetary policy to regulate the economy. So, an increase in reserve requirement will make the banks lend less that in turn reduces the level of money supply in the economy.