The reserve requirement (or required reserve ratio) is the percentage of customer deposits that banks must hold as reserves rather than lend out. In AP Macro, it determines the maximum money multiplier (1/rr) and serves as a tool of monetary policy in a limited-reserves banking system.
The reserve requirement is a rule set by the central bank that tells commercial banks what percentage of their deposits they must keep on hand as reserves, either as vault cash or in their account at the central bank. If the reserve requirement is 10% and you deposit $1,000, the bank must hold $100 as required reserves. Anything it holds beyond that is excess reserves, and excess reserves are what banks lend out to create new money (EK POL-2.A.3 and POL-2.A.4).
This is the heart of fractional reserve banking. Because banks only hold a fraction of deposits, every new deposit can fuel a chain of loans and re-deposits that expands the money supply. The reserve requirement caps that chain by setting the maximum money multiplier, which equals 1 divided by the required reserve ratio. A 10% requirement means a multiplier of 10, so a $100 injection of new reserves can grow the money supply by up to $1,000. One catch worth knowing for the modern CED: the United States now operates with ample reserves, and the Fed actually set the reserve requirement to zero in 2020. The CED still lists it as a tool, but flags that it matters in limited-reserves systems, not the current U.S. one.
The reserve requirement lives in Unit 4 (Financial Sector) and shows up in three topics at once. In Topic 4.4 it powers the money multiplier and balance sheet calculations (LO 4.4.A, 4.4.B, and 4.4.C). In Topic 4.6 it appears on the official list of monetary policy tools alongside open market operations and the discount rate (EK POL-1.D.2). And through Topic 4.5, any change in the reserve requirement shifts money supply in the money market, which moves the nominal interest rate (LO 4.5.D and 4.5.E). It is one of the cleanest ways the exam tests whether you can trace a policy action all the way from a bank's balance sheet to interest rates to aggregate demand.
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Money Multiplier (Unit 4)
The reserve requirement and the money multiplier are two sides of the same coin. The multiplier is just 1 divided by the required reserve ratio, so a lower requirement means a bigger multiplier and more potential money creation from every dollar of new reserves.
Excess Reserves (Unit 4)
Required reserves are the part of deposits banks must sit on; excess reserves are everything above that. Only excess reserves get lent out, so raising the requirement converts loanable excess reserves into locked-up required reserves and shrinks lending.
Expansionary Monetary Policy (Unit 4)
Lowering the reserve requirement is the expansionary version of this tool. It frees up excess reserves, expands money supply, lowers the nominal interest rate in the money market, and boosts interest-sensitive spending and aggregate demand.
Bank Balance Sheets (Unit 4)
Calculation questions hand you a T-account and a reserve requirement, then ask for required reserves, excess reserves, or maximum new loans. The requirement is the number that splits the reserves line on the balance sheet into its two pieces.
Multiple-choice questions test the reserve requirement two ways. First, as a calculation: given a reserve ratio and a deposit, find required reserves, excess reserves, the money multiplier, or the maximum change in the money supply. Second, as a policy tool: a stem describes a macro problem (inflation above target, an economy at potential output, a severe recession) and asks which action fits. Know the direction cold. Lowering the requirement is expansionary; raising it is contractionary. Practice questions also test the short-run chain: lower requirement, money supply rises, nominal interest rate falls, investment rises, AD shifts right, output and price level rise. On FRQs, this same logic shows up in balance sheet questions and money market graphs, so be ready to show the money supply curve shifting and label the new equilibrium nominal interest rate. Also remember the CED's nuance from EK POL-1.D.2 that the U.S. now runs an ample-reserves system, so the Fed relies on administered rates like interest on reserves rather than the reserve requirement.
The reserve requirement is a percentage (a ratio, like 10%); required reserves are a dollar amount (10% of 500). Exam calculation questions punish mixing these up. When a question says 'the reserve requirement is 20%,' you multiply it by deposits to get required reserves, then subtract from total reserves to find excess reserves.
The reserve requirement is the percentage of deposits that banks must hold as reserves instead of lending out.
The maximum money multiplier equals 1 divided by the required reserve ratio, so a 10% requirement means a multiplier of 10.
Lowering the reserve requirement is expansionary because it creates excess reserves, increases the money supply, and lowers the nominal interest rate; raising it does the opposite.
Required reserves are deposits times the reserve ratio, and excess reserves (total reserves minus required reserves) are what banks can actually lend to create new money.
The reserve requirement is a meaningful policy tool only in a limited-reserves banking system; the U.S. has ample reserves and set its requirement to zero in 2020, relying instead on administered rates like interest on reserves.
It is the percentage of customer deposits that banks must hold as reserves, set by the central bank. It determines the money multiplier (1/rr) and is listed in the CED as one of the tools of monetary policy alongside open market operations and the discount rate.
Yes. A lower requirement turns required reserves into excess reserves, which banks can lend out. More lending means more deposit creation, a larger money multiplier, and an increase in the money supply, which pushes the nominal interest rate down.
The reserve requirement is a percentage of deposits banks must hold; the discount rate is the interest rate the central bank charges banks for loans. Both are monetary policy tools, but one restricts how much banks can lend while the other changes the cost of borrowing reserves.
Not actively. The Fed set the reserve requirement to 0% in 2020 because the U.S. banking system has ample reserves, and the CED notes that monetary policy tools differ between limited-reserves and ample-reserves systems. You still need the concept for multiplier and balance sheet questions, though.
Divide 1 by the required reserve ratio. A 20% requirement gives a multiplier of 1/0.20 = 5, so a $200 injection of new excess reserves can expand the money supply by up to $1,000.