What best explains why raising the required reserve ratio results in a decease in the money supply?

The reserve ratio is the percentage of deposits that a commercial bank is required to keep on reserve and not lend out. Lowering the reserve ratio increases the money supply in an economy because it permits banks to lend out more money. When the reserve ratio is lowered banks can use the same amount of deposits to create more loans which increases the money supply.

The increase in the money supply following a decrease in the reserve ratio is due to the process of fractional reserve banking. This process allows commercial banks to lend out more money than they have in deposits. For example if the reserve ratio is 10% then a bank can lend out 90% of its total deposits. If the reserve ratio is lowered to 5% the bank can lend out 95% of its deposits. This increased lending expands the money supply in the economy.

The increase in the money supply resulting from a decrease in the reserve ratio has several effects. First it increases the money available for lending which can lead to increased investment and consumption. Second it lowers interest rates which makes borrowing more attractive. Finally it can lead to inflation if the money supply increases faster than economic output. For these reasons central banks must carefully consider the impact of changes to the reserve ratio.