In an economy where the money supply and aggregate demand have been decreased by the central bank, you know that the central bank is using a contractionary monetary policy.
In an economy, changes in the money supply leads to changes in aggregate demand. An increase in the money supply increases aggregate demand and a decrease in the money supply decreases aggregate demand.
When a central bank takes action in order to decrease the money supply and increase the interest rate, it is following a contractionary monetary policy. Thus, the central bank requires Southern to hold 10% of deposits as reserves.
Hence, the decrease in the money supply reduces income and raises the interest rate.
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