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Reserve requirements: A modern perspective

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Author Info

  • Scott E. Hein
  • Jonathan D. Stewart

Abstract

The discussion in many money and banking textbooks would suggest that the Federal Reserve requires depository institutions to hold a minimum level of non-interest-earning reserves because (1) reserve requirements are a monetary policy tool that allows the Fed to expand the money supply and lower interest rates, and (2) reserve requirements improve the safety and soundness of depository institutions. This article argues that this "conventional wisdom" view is too narrow. ; The Fed often uses reserve requirement changes, the authors contend, to achieve non-monetary-policy objectives, as it did in 1992 to improve the profitability of depository institutions and ease the credit crunch of that time. The authors also challenge the notion that higher reserve requirements necessarily lead to greater safety and lower default risk for depository institutions. ; The article examines the relationship between reserve requirement changes and monetary policy, with the aim of demonstrating the recent, limited usefulness of reserve requirements as a monetary policy tool. The article proposes a more modern view of reserve requirements as a tax on depository institutions, ponders who really bears this tax, and summarizes a large and growing literature suggesting that perceived bank profitability is inversely affected by announced changes in reserve requirement ratios. The article also provides new evidence that the 1992 reserve requirement reductions were not associated with an increase in default risk for financial institutions that issue reservable instruments, as the conventional view would suggest.

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Bibliographic Info

Article provided by Federal Reserve Bank of Atlanta in its journal Economic Review.

Volume (Year): (2002)
Issue (Month): Q4 ()
Pages: 41-52

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Handle: RePEc:fip:fedaer:y:2002:i:q4:p:41-52:n:v.87no.4

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Related research

Keywords: Monetary policy ; Financial institutions ; Bank reserves;

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Cited by:
  1. Fulbert Tchana Tchana, 2009. "The Empirics of Banking Regulation," Working Papers 128, Economic Research Southern Africa.
  2. Carrera, César, 2012. "Políticas de Encajes y Modelos Económicos," Working Papers 2012-006, Banco Central de Reserva del Perú.
  3. Xiaohui Zhang & Zhihong Ji & Yong Cui, 2009. "Reserve requirement, reserve requirement tax and money control in China: 1984–2007," Frontiers of Economics in China, Springer, vol. 4(3), pages 361-383, September.
  4. Koray Alper & S. Tolga Tiryaki, 2011. "Zorunlu Karsiliklarin Para Politikasindaki Yeri," CBT Research Notes in Economics 1108, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.

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