Series 65: 1.2.1.2.3 Altering Reserve Requirements

1.2.1.2.3  Altering Reserve Requirements

The Fed also implements monetary policy with its power to change reserve requirements. A reserve requirement is the amount of funds the Fed requires that depository institutions, such as banks, hold in reserve against deposits made by their customers. To stimulate the economy, the Fed lowers the reserve requirements, allowing banks to lend out more money. Americans then have more money available to invest and spend.

To slow the economy and lower inflation, the Fed may raise the reserve requirements, causing banks to tighten the amount of money they have available to lend. This tightening of credit can slow investment in new business and reduce spending, resulting in an economic slowdown. Raising the reserve requirements can reduce inflation because consumers spend less, driving down prices.