China’s GDP Growth Set to Dip, Raising Pressure for More Stimulus

Answer the following questions to check your understanding of the story.

1) What is the required reserve ratio?

a) The maximum percentage of deposits that banks can lend out to consumers and firms.

b) The minimum percentage of liquid assets that depository institutions are required to hold as reserves.

c) The minimum percentage of deposits that depository institutions are required to hold as reserves.

d) The percentage of deposits that depository institutions plan to hold as reserves.

Wrong! - Is the required reserve ratio set by the central bank or chosen by depository institutions? Do depository institutions loan out their required reserves? Are required reserves a percentage of a depository institution’s liquid assets?

Well Done! - The required reserve ratio is the minimum percentage of deposits that depository institutions are required to hold as reserves. They are used to meet depositors’ currency withdrawals and to make payments to other banks.

2) What is the immediate effect of lowering the required reserve ratio on total reserves in the banking system?

a) Total reserves remain unchanged—excess reserves decrease and required reserves increase by an equal amount.

b) Total reserves decrease—required reserves decrease by more than the increase in excess reserves.

c) Total reserves remain unchanged—excess reserves increase and required reserves decrease by an equal amount.

d) Total reserves increase because new reserves are created by the central bank.

Wrong! - What is the composition of a depository institution’s total reserves? What is the difference between required reserves and excess reserves?

Good Job! - When the required reserve ratio decreases, some reserves that were previously required reserves now become excess reserves. Total reserves remain unchanged.

3) What is the effect of decreasing the required reserve ratio on the quantity of money?

a) The quantity of money decreases.

b) The quantity of money increases.

c) The quantity of money doesn’t change.

Wrong! - When the required reserve ratio decreases, how do a bank’s excess reserves and its loans change? What is the effect on the quantity of money?

That's Right! - When the required reserve ratio decreases, banks have more excess reserves to loan out. The quantity of money increases.

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