Assume that the required reserve ratio is 25%. If the Fed buys $5 million worth of      government bonds from the public, the maximum change in the money supply is:   a) -$20 million. (b) -$12.5 million.   (c) $12.5 million.  (d) $20 million.

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Required Reserve and Excess Reserve Analysis

A required reserve is an amount of cash that banks must keep with themselves, which is certain percentage of the deposits made by their customers. Required reserve is a percentage of the bank's deposits that the respective bank must have on each overnight. The percentage rate is set and determined by the nation’s central bank. It is important to have such funds accumulated to meet its uncertain obligations, sudden liabilities and withdrawals. Required reserve is also known as reserve ratio. Reserve ratio is an important tool to control the money supply.