A:

The Federal Reserve would change the reserve ratio if it wanted to use that part of its monetary policy to either expand the economy and spur economic growth or contract the economy to slow down growth.

The Federal Reserve's Monetary Policy

The Federal Reserve's monetary policy refers to one of the ways that the U.S. government tries to regulate and control the economy. If the money supply grows too quickly, the inflation rate will increase faster than the Federal Reserve wants. If the money supply grows too slowly, the growth of the economy will be too slow.

The Federal Reserve uses its monetary policy to control the money supply in the economy and balance economic growth with inflation. There are three ways in which the Federal Reserve can control the supply of money: by adjusting the discount rate, by adjusting the reserve requirements or reserve ratio and through open market operations, which is the purchase and selling of government securities.

The Reserve Ratio

The reserve ratio is the percentage requirement of cash that banks must hold on hand. The cash can be held within the banks vaults themselves or at the closest Federal Reserve bank. The actual percentage depends on the size of the bank's total assets.

When the Federal Reserve wants to expand the economy through an expansionary policy, it reduces the reserve ratio, meaning that banks have more cash on hand to loan out to consumers and businesses. When the Federal Reserve wants to contract the economy through a contractionary policy, it will increase the reserve ratio, reducing the amount of loans that banks will be able to make.

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