Future Business Leader Achievments (FBLA) Economics Practice Exam

If the Fed reduces the reserve requirements from 20 percent to 15 percent, what is the immediate effect?

1. Increase excess reserves and increase the money supply.

2. Decrease excess reserves and increase the money supply.

3. Increase excess reserves and decrease the money supply.

4. Decrease excess reserves and decrease the money supply.

The correct answer is: Increase excess reserves and increase the money supply.

When the Federal Reserve reduces the reserve requirements, financial institutions are allowed to hold a smaller percentage of their deposits in reserve and can therefore lend out more money. In this scenario, reducing the reserve requirement from 20 percent to 15 percent means that banks can keep less cash on hand and will have more liquidity available for lending. As a result, excess reserves—which are the funds banks hold beyond what is required—will increase because banks now have more capacity to lend. This increased lending capability allows banks to create more money through the money multiplier effect, thereby increasing the overall money supply in the economy. Thus, the immediate effect of lowering the reserve requirement is an increase in excess reserves coupled with an increase in the money supply, supporting the correct answer option.