Which of the following statements is NOT true about the reserve requirement?

• A. The reserve requirement refers to the minimum fraction of deposits that banks must hold in reserve.
• B. A higher reserve requirement increases the money supply in the economy.
• C. Lowering the reserve requirement can encourage banks to lend more.
• D. The reserve requirement is set by the central bank.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the definition of the reserve requirement. It is the minimum fraction of customer deposits that banks are required to keep as reserves, either in their vaults or at the central bank, and not lend out.
2. Step 2: Analyze the effect of changing the reserve requirement on the money supply. When the reserve requirement increases, banks must hold more reserves and have less to lend, which typically decreases the money supply.
3. Step 3: Conversely, when the reserve requirement decreases, banks can lend a larger portion of their deposits, which tends to increase the money supply.
4. Step 4: Recognize that the reserve requirement is a tool set by the central bank to regulate the banking system and control liquidity in the economy.
5. Step 5: Identify the incorrect statement by comparing the effects described: the statement claiming that a higher reserve requirement increases the money supply contradicts the fundamental relationship between reserve requirements and lending capacity.