Required Reserve Ratio Flashcards, test questions and answers

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What is Required Reserve Ratio?

The required reserve ratio is an important tool used by central banks to control the money supply and inflation in an economy. It refers to the percentage of a bank’s deposits that must be held as reserves, either in the form of cash or other assets such as government bonds. The ratio dictates how much money banks are allowed to lend out, which influences both economic activity and inflation.When setting the required reserve ratio, central banks must carefully consider the current economic conditions in order to achieve their goals of controlling inflation and encouraging economic growth. If a central bank believes there is too much money floating around in the economy and causing prices to rise quickly (high inflation), it will increase its required reserve ratio so that less money can be lent out by banks. This reduces total spending power and should bring prices down eventually. On the other hand, if a central bank sees slow economic growth due to low levels of spending, it may reduce its required reserve ratio so that more money can be loaned out by banks, stimulating more spending and investment which can help fuel faster economic growth.An effective use of the required reserve ratio therefore requires careful consideration of both short-term and long-term objectives while taking into account prevailing market conditions at any given time. When done properly, this tool can help maintain macroeconomic stability while also promoting sustainable long-term growth.