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Monetary policy without reserve requirements: analytical issues

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  • Gordon H. Sellon, Jr.
  • Stuart E. Weiner
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    Abstract

    Reserve requirements have traditionally been viewed as a key instrument of monetary policy. Indeed, textbook discussions of monetary policy typically center on the role of reserve requirements in determining the size of the money multiplier and the magnitude of bank credit expansion. In recent years, however, there has been a significant decline in the use of reserve requirements in the United States and in other industrialized countries. Many countries have made substantial cuts in the level of reserve requirements, and some countries have eliminated reserve requirements altogether.> The declining use of reserve requirements has two important implications for monetary policy. First, in the absence of a binding level of reserve requirements, the demand for central bank balances is no longer determined by the public's demand for transactions and term deposits but, instead, depends on depository institutions' need to hold balances for clearing and settlement purposes. This means that there is a direct connection between the payments system and monetary policy and implies that institutional changes in the payments system, such as new clearing and settlement methods, may require corresponding changes in monetary policy operating procedures. Second, the absence of binding reserve requirements may lead to increased volatility of short-term interest rates and impair the ability of central banks to implement monetary policy. If so, central banks may have to adapt operating procedures to contain this volatility.> In the first of two articles, Sellon and Weiner analyze the implications for monetary policy of the declining use of reserve requirements. The companion article, to be published in a future issue of the Review, will look at three countries that have eliminated reserve requirements Canada, the United Kingdom, and New Zealand and ask whether adaptations to monetary policy procedures in those countries could be extended to the United States.

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    Bibliographic Info

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

    Volume (Year): (1996)
    Issue (Month): Q IV ()
    Pages: 5-24

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    Handle: RePEc:fip:fedker:y:1996:i:qiv:p:5-24:n:v.81no.4

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    Keywords: Monetary policy ; Bank reserves;

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