suppose you deposit $200 in your checking account at your bank, which has a required reserve ratio of 20%. Initially, as a result of your this transaction, the size of M1 will . Before any further actions by your bank, the reserves in your bank by, while the excess reserves of your bank by

If the required reserve ratio is 20 percent, then starting with new reserves of, say, $200, the most a bank can lend is $160, since it must keep $40 as reserves against the deposit it simultaneously sets up.

The amount of reservable liabilities that commercial banks must keep onto rather than lend out or invest is known as the reserve ratio. The central bank of the nation, in this case the Federal Reserve in the United States, sets this criterion. Banks are required to retain 10% of their deposits in necessary reserves if the statutory reserve ratio is 10%. Deposits of $20 million require necessary reserves to be retained at $2 million ($20 million multiplied by. 10). Reserves over and above those that are necessary are called excess reserves. In the absence of additional measures, raising the reserve requirement ratios reduces the amount of deposits that can be supported by a certain level of reserves, lowers the money supply, and rises the cost of credit. Banks are able to extend more loans to individuals and businesses when the reserve ratio is reduced by the Federal Reserve. This lowers the amount of cash that banks must store in reserves. The economy grows as a result, increasing the money supply in the country.

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