What effect does a change in the reserve requirement ratio have on the
Reserve requirements are one of the three monetary policy tools the Federal
Reserve uses to implement monetary policy. However, in recent years the
Fed has seldom employed changes in reserve requirements to enact monetary
policy, because open market operations are a much more precise tool.
What Are Reserve Requirements?
Banks and other depository institutions (savings institutions, credit
unions, and foreign banking entities) are required to hold a portion of
their deposits as reserves. Depository institutions may hold reserves
either as vault cash or as deposits with Federal Reserve Banks.
Effective December 28, 2000, depository institutions were required to
hold a reserve requirement of 3 percent against their first $42.8 million
in net transaction accounts (demand and other checkable deposits) and
10 percent against their net transaction accounts above $42.8 million.
At present, there is no reserve requirement on time and savings deposits.
The table shows that aggregate required reserves of depository institutions
were $36.9 billion as of June 2001, according to the Federal Reserve Boards
H.3 Statistical Release.
Reserve Requirement Changes Affect the Money Stock
Purpose and Functions (1994) describes how a change in the reserve
requirement ratio affects bank credit and the money stock.
Reserve requirements are the percentage of deposits that depository institutions
must hold in reserve and not lend out. For example, with a 10 percent
reserve requirement on net transaction accounts, a bank that experiences
a net increase of $200 million in these deposits would be required to
increase its required reserves by $20 million. The bank would be able
to lend the remaining $180 million of deposits, resulting in an increase
in bank credit. As those funds are lent, they create additional deposits
in the banking system. The increase in deposits affects the money stock,
because it is measured in several ways that primarily include various
categories of deposits and currency in the hands of the public.
- Increasing the (reserve requirement) ratios reduces the volume
of deposits that can be supported by a given level of reserves and,
in the absence of other actions, reduces the money stock and raises
the cost of credit.
- Decreasing the ratios leaves depositories initially with excess
reserves, which can induce an expansion of bank credit and deposit levels
and a decline in interest rates.
The volume of net transaction deposits held by all depository institutions
is large, $566.5 billion, as of June 2001 (see table and H.6 Release).
Thus, even a small change in the reserve requirement ratio may have a
relatively large effect on reserve requirements and the money stock.
Few Changes in Reserve Requirements
There are several reasons why reserve requirements are not frequently
changed, the most important of which is that open market operations provide
a much more precise tool for implementing monetary policy. When the Fed
purchases $10 billion in securities for its own portfolio, it adds $10
billion to bank reserves.
The impact of changes in reserve requirements is difficult to estimate;
each change has the potential to affect thousands of depository institutions
in different ways, depending on each institution's deposit base. Changes
in reserve requirements also typically lead to changes in pricing schedules
for some bank services, because some bank fees and credits are set based
on reserve requirements.
Aggregate Reserves of Depository Institutions
and the Monetary Base. H.3 Statistical Release. The Board of Governors
of the Federal Reserve System, Washington, DC. http://www.federalreserve.gov/releases/
Federal Reserve Bulletin, The Board of Governors
of the Federal Reserve System, Washington, DC. See Financial and Business
Statistics. Table 1.15, Reserve Requirements of Depository Institutions,
provides current reserve requirements and their effective dates.
Money Stock and Debt Measures. H.6 Statistical
Release. The Board of Governors of the Federal Reserve System, Washington,
Purposes & Functions (1994), The Federal
Reserve System, Washington, DC,. 9/14/2001. http://www.federalreserve.gov/pf/pdf/frspf3.pdf
Reserve Requirements, FedPoint Publications,
Federal Reserve Bank of New York, New York, 9/14/2001. http://www.ny.frb.org/pihome/fedpoint/fed45.html