ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Higher interest rates translate to a lower supply of money in the economy. Since the supply of money depletes, it raises borrowing costs, which makes it more expensive for consumers to hold debt.

Detailed explanation-2: -Holding interest on reserves fixed, an increase in bank reserves would increase the aggregate supply of broad liquidity. Thus, open market operations would have the potential to manage productively the aggregate quantity of broad liquidity in the economy independently of interest rate policy.

Detailed explanation-3: -Every time a dollar is deposited into a bank account, a bank’s total reserves increases. The bank will keep some of it on hand as required reserves, but it will loan the excess reserves out. When that loan is made, it increases the money supply. This is how banks “create” money and increase the money supply.

Detailed explanation-4: -Conversely, the Fed increases the reserve ratio requirement to reduce the amount of funds banks have to lend. The Fed uses this mechanism to reduce the supply of money in the economy and control inflation by slowing the economy down.

Detailed explanation-5: -Raising the reserve requirement reduces the amount of money that banks have available to lend. Since the supply of money is lower, banks can charge more to lend it. That sends interest rates up.