Reducing bank reserves leads to lower money supply?

I read this in Example 18, Reading 14 Aggregate Output, Prices, and Economic growth.
“The Brazilian central bank reduced bank reserves, resulting in a lower money supply.”
If a central bank reduces bank reserves, this means commercial banks don’t have to maintain an important cash reserve in order to lend money, so this necessarly leads to a higher money supply, since banks can lend more for less cash in reserve.

I’m also reading on a prep provider notes that increasing bank reserves leads to more money supply. How come you have more money supply when you are required to hold more cash in your accounts to lend money? Doesn’t the money multiplier decrease when you increase your bank reserves !?

Hi ProfitableTea,

After reviewing that reading and the Econ reading: “Money: Functions, Creation, and Definition” I have two responses for you.

a) Per the above Econ reading your understanding of the reserve requirement (a ratio) is correct - the lower the reserve requirement, the more banks can lend and the higher the money supply.


b) Example 18 is referring to bank reserves (a finite amount and different concept). With less reserves in their vaults banks have less money to loan out.

In the example, the central bank is not changing the reserve requirement just the bank reserves and one way they can do this is by selling bonds.

Please feel free to correct me or improve upon this response. Hope this answers your question, they’re easy to confuse. Reviewing the difference helped my understanding as well. Good luck!

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Thanks sam :slight_smile: ! Your response helped a lot. Glad this helped you with your understanding as well!