Graph walkthrough · Macro · Money market

A lower reserve requirement

The central bank lowers the share of deposits banks must hold as reserves.

Step 1 of 3 · Before the cut

The horizontal axis is the quantity of money. The vertical axis is the nominal interest rate. Money demand slopes down and money supply is vertical. The market is at E₀.

The chain in words

Step 1
Before the cut
The horizontal axis is the quantity of money. The vertical axis is the nominal interest rate. Money demand slopes down and money supply is vertical. The market is at E₀.
Step 2
Money supply shifts right
Banks that must hold fewer reserves can lend more of each deposit. Loans create deposits, so the money stock grows. Money supply shifts right. At the old interest rate, people hold more money than they want.
Step 3
The interest rate falls
People buy bonds with the extra money. Bond prices rise and the interest rate falls to E₁, where the larger money stock is willingly held.

Takeaway. Lowering the reserve requirement raises the money supply and lowers the interest rate.

Draw it yourself

This shock: draw the graph The Fed buys bonds The Fed sells bonds Incomes rise, more transactions

More on the money market graph

The Fed buys bonds The Fed sells bonds Holiday spending raises money demand Higher prices, more money demanded

Go deeper

Lesson: Central Bank Tools

The walkthrough shows the chain. The lesson explains why each link holds, with worked examples and practice questions that remember what you get wrong.

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