Which of the following is not a consequence of the Fed changing the required reserve ratio?
A. increasing the ratio will decrease the amount of reserves banks have to loan
B. changes in the ratio effectively places a tax on banks’ deposit taking and lending activities
C. decreasing the ratio will increase excess reserves
D. changes in the ratio are easily incorporated into banks’ routine management
The correct answer and explanation is:
The correct answer is D. changes in the ratio are easily incorporated into banks’ routine management.
Explanation:
The Federal Reserve (Fed) can adjust the required reserve ratio, which is the fraction of deposit liabilities that a commercial bank must hold in reserve rather than lend out. These adjustments have significant consequences for the banking system.
- A. Increasing the ratio will decrease the amount of reserves banks have to loan: This statement is true. When the Fed increases the required reserve ratio, banks must hold more reserves, which reduces the amount of money they have available to lend. As a result, the money supply contracts, and banks have less ability to extend loans.
- B. Changes in the ratio effectively place a tax on banks’ deposit taking and lending activities: This is also correct. Increasing the required reserve ratio makes it more expensive for banks to lend and take deposits because they must hold a larger portion of their funds in reserve rather than using them for loans or investments. This can reduce the profitability of banks, acting like a “tax” on their operations.
- C. Decreasing the ratio will increase excess reserves: This statement is true as well. When the Fed decreases the required reserve ratio, banks are allowed to hold fewer reserves, freeing up excess reserves. These reserves can then be used for loans, investments, or other financial activities, which increases the available supply of money in the economy.
- D. Changes in the ratio are easily incorporated into banks’ routine management: This statement is false. Changes to the reserve requirement often have significant operational consequences for banks. These adjustments are not trivial and may require banks to change their management of reserves, adjust their lending practices, or even restructure their operations to maintain compliance with the new requirements. Consequently, it is not easy or routine for banks to adjust to these changes without affecting their overall activities.
Thus, D is the correct answer because it downplays the complexity of adjusting to changes in the reserve requirement ratio.