The reserve ratio (reserve requirement) is the fraction of checkable deposits that banks must hold as reserves rather than lend out. In AP Macro, it determines the money multiplier (1/reserve ratio) and is one of the central bank's tools for changing the money supply.
The reserve ratio, also called the reserve requirement, is the percentage of deposits a bank has to keep on hand (as vault cash or deposits at the central bank) instead of lending out. If the reserve ratio is 10%, a bank that takes in a $1,000 deposit must hold $100 in required reserves and can lend out up to $900. That $900 gets deposited somewhere else, gets partially lent again, and the process repeats. This is fractional reserve banking, and it's how banks create money.
The reserve ratio matters for two reasons. First, it keeps banks liquid, meaning they have enough cash to cover withdrawals. Second, it controls how much money the banking system can create from each new deposit. The money multiplier equals 1 divided by the reserve ratio, so a 10% requirement means a multiplier of 10, while a 25% requirement means a multiplier of 4. A higher reserve ratio means less lending and a smaller money supply; a lower ratio means more lending and a larger money supply. That makes the reserve requirement a lever the central bank can pull when conducting monetary policy.
The reserve ratio shows up in Unit 5 under Topic 5.1, Fiscal and Monetary Policy Actions in the Short-Run, supporting learning objective 5.1.A on explaining the effects of combined fiscal and monetary policy actions. The logic chain you need is this. Lowering the reserve requirement lets banks lend more, which increases the money supply, lowers interest rates, and boosts investment spending and aggregate demand. Raising it does the opposite. The CED's essential knowledge for 5.1.A is all about using expansionary or contractionary policy to close recessionary or inflationary output gaps, and the reserve ratio is one of the monetary tools that makes the 'monetary' half of that combination work. It also leans on Unit 4 foundations, since you can't use the reserve ratio without the money multiplier math from the banking and money creation topics.
Keep studying AP Macroeconomics Unit 5
Money Multiplier (Unit 4)
These two are mathematically joined at the hip. The money multiplier is just 1 divided by the reserve ratio, so a 20% reserve requirement means each new dollar of reserves can support up to $5 of new money. If an exam question gives you one, you can always find the other.
Monetary Policy (Units 4-5)
The reserve requirement is one of the central bank's classic tools, alongside open market operations and the discount rate. Lowering the requirement is expansionary because it frees up reserves for lending; raising it is contractionary because it locks reserves away.
Expansionary Monetary Policy (Unit 5)
When the economy sits in a recessionary gap, cutting the reserve ratio increases lending, expands the money supply, lowers interest rates, and raises investment and aggregate demand. That's the full transmission chain 5.1.A wants you to explain, especially when monetary policy is paired with fiscal policy.
Liquidity (Unit 4)
The original point of reserve requirements was bank safety. Forcing banks to hold a cushion of reserves means they can handle a normal day of withdrawals without scrambling. The policy use (controlling the money supply) grew out of that stability role.
Reserve ratio questions are mostly math and mechanics. Multiple-choice stems give you a reserve requirement and a deposit, then ask for required reserves, excess reserves, the maximum new loan a single bank can make, or the maximum change in the money supply across the whole banking system. Watch the difference between what one bank can lend (the deposit minus required reserves) and what the system can create (excess reserves times the money multiplier). FRQs often hand you a bank balance sheet and walk you through those calculations, then ask how a change in the reserve requirement would affect the money supply, interest rates, and aggregate demand. No released FRQ in recent memory hinges on the term alone, but the reserve-ratio-to-multiplier-to-money-supply chain is a recurring FRQ move, and under 5.1.A you may need to combine it with a fiscal policy action to explain the overall effect on output and the price level. One real-world note worth knowing but not panicking over. The Fed actually set the reserve requirement to 0% in 2020, but AP Macro's limited reserves framework still tests the traditional math, so learn it.
The reserve ratio and the money multiplier are reciprocals, not the same thing. The reserve ratio is the fraction of deposits banks must hold (say, 10%), while the money multiplier is the maximum factor by which new reserves expand the money supply (1/0.10 = 10). A common exam mistake is multiplying a deposit by the reserve ratio when the question asks for the money supply change, which needs the multiplier instead. Quick check on direction. A higher reserve ratio means a smaller multiplier, so the two always move in opposite directions.
The reserve ratio (reserve requirement) is the fraction of deposits banks must hold as reserves instead of lending out.
The money multiplier equals 1 divided by the reserve ratio, so a 10% requirement gives a multiplier of 10.
Lowering the reserve requirement is expansionary monetary policy because banks can lend more, which increases the money supply and lowers interest rates.
Raising the reserve requirement is contractionary because it shrinks lending and the money supply.
A single bank can lend out only its excess reserves, but the whole banking system can create new money equal to excess reserves times the money multiplier.
Under learning objective 5.1.A, a reserve ratio change can be combined with fiscal policy to close a recessionary or inflationary output gap.
It's the fraction of checkable deposits that banks must hold as reserves rather than lend out. With a 10% reserve ratio, a bank receiving a $1,000 deposit must hold $100 and can lend up to $900.
No, they're reciprocals. The money multiplier equals 1 divided by the reserve ratio, so a 20% reserve ratio means a multiplier of 5. Higher reserve ratio, smaller multiplier.
No, it does the opposite. Raising the requirement forces banks to hold more and lend less, which shrinks the money supply and raises interest rates. That makes it a contractionary monetary policy tool.
The reserve requirement is the fraction of deposits banks must hold, while the discount rate is the interest rate the central bank charges banks for loans. Both are monetary policy tools, but one controls how much banks can lend and the other affects how cheaply banks can borrow reserves.
Find the money multiplier (1/reserve ratio), then multiply it by the change in excess reserves. For example, with a 10% reserve ratio, $500 of new excess reserves can create up to $5,000 of new money across the banking system.