Question

Assuming a banking system with limited reserves, which of the following actions by the central bank reduces the

ability of the banking system to create money?
(A) Decreasing the policy rate
(B) Decreasing the discount rate
(C)) Increasing the money supply
(D) Increasing the reserve requirement
(E) Buying government bonds on the open market

Answer 1

The correct answer is (D) Increasing the reserve requirement. When the reserve requirement is increased, banks are required to hold a higher percentage of their deposits in reserve and have less money available to lend out. This decreases the ability of the banking system to create money.

Decreasing the policy rate and buying government bonds on the open market are actions that increase the money supply and the ability of the banking system to create money. Decreasing the discount rate makes it easier for banks to borrow from the central bank and therefore increases the money supply.