Question

Legal reserve requirements are changed (L.O2) a) very often b) on rare occasions c) never d) none of these

Short answer

The correct answer is (b) on rare occasions. Legal reserve requirements are changed infrequently and only when necessary to maintain financial stability or address economic issues.

Step-by-step solution

Understand Legal Reserve Requirements

Legal reserve requirements are the amount of money that banks and other financial institutions are required to keep as a minimum reserve. These requirements are set by the Central Bank or government authorities to control the money supply and maintain the stability of the financial system.

Evaluate the Options

Go through each answer choice and determine how frequently legal reserve requirements change. a) very often: Legal reserve requirements are not changed very often, as they are a form of monetary policy and major changes can affect the stability of the financial system. b) on rare occasions: This answer seems more reasonable. Reserve requirements may be altered during financial or economic crises to restore stability or encourage lending. Still, these changes are not done frequently or without significant consideration. c) never: This is incorrect because changes to reserve requirements have occurred in the past, and they may also be altered when necessary. d) none of these: This option can be discarded as it suggests that no choice is correct, but we have already established that option (b) seems appropriate.

Choose the Correct Answer

Based on the evaluation of the options, we can conclude that the correct answer is (b) on rare occasions. Legal reserve requirements are changed infrequently and only when necessary to maintain financial stability or address economic issues.

Key concepts

Monetary Policy

Monetary policy plays a crucial role in shaping a country's economic environment. It refers to the actions by which a central bank or monetary authority manages the supply and availability of money in the economy. Legal reserve requirements are a key instrument used in monetary policy.
By adjusting reserve requirements, central banks can influence how much money banks have available to lend to businesses and consumers. This, in turn, affects interest rates and overall economic activity.
When a central bank wants to expand the money supply, it may lower reserve requirements, allowing banks to loan out more money. Conversely, raising the reserve requirement restricts the amount banks can lend, thereby reducing the money supply.

• Lowering reserve requirements can stimulate economic growth by making more funds available for borrowers.
• Increasing reserve requirements can help cool down an overheating economy.
Central banks use these adjustments cautiously to avoid unexpected repercussions on the economy and maintain financial stability.

Central Bank

A central bank stands as the key financial institution responsible for managing a nation's currency and monetary policy. This authority strives to achieve various economic goals like controlling inflation, managing employment levels, and stabilizing the financial system.
Central banks also set the legal reserve requirements for commercial banks, directly affecting how much money is available in the economy. This power allows them to manage economic fluctuations and contribute to financial security.
Through tools such as open market operations, interest rate adjustments, and reserve requirements, central banks ensure that the economy operates smoothly. They also act as a lender of last resort to the banking sector during financial distress.

• Central banks promote economic growth by influencing monetary conditions.
• They aim to keep inflation rates at an optimal level for the economy.
• Central banks maintain financial stability by overseeing commercial banks and implementing monetary policy.

Financial Stability

Financial stability is the term used to describe a condition where the financial system, including institutions like banks and markets, operates effectively and reflects the economy’s needs without causing disruptions.
Legal reserve requirements contribute to this stability by ensuring that banks have enough funds to cover customer withdrawals and settle obligations. They prevent situations where banks might run out of cash unexpectedly, which could lead to financial panic or crises.
Central banks closely monitor various indicators and adjust reserve requirements as a preventive measure to support stability. These adjustments are often made during economic downturns or periods of financial uncertainty to provide a buffer against potential disruptions.

• Financial stability allows for sustainable economic growth and consumer confidence.
• Sound policy measures ensure that financial institutions can withstand economic shocks.
• Central banks act promptly to correct imbalances, protecting the economy from long-term damage.

Maintaining financial stability is vital for achieving a prosperous and resilient economic environment.