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Should We Worry About Excess Reserves?

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  • Christopher Phelan

Abstract

Banks in the United States have the potential to increase liquidity suddenly and significantly?from $12 trillion to $36 trillion in currency and easily accessed deposits?and could thereby cause sudden inflation. This is possible because the nation?s fractional banking system allows banks to convert excess reserves held at the Federal Reserve into bank loans at about a 10-to-1 ratio. Banks might engage in such conversion if they believe other banks are about to do so, in a manner similar to a bank run that generates a self-fulfilling prophecy. {{p}} Policymakers could guard against this inflationary possibility by the Fed selling financial assets it acquired during quantitative easing or by Congress significantly raising reserve requirements.

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  • Christopher Phelan, 2015. "Should We Worry About Excess Reserves?," Economic Policy Paper 15-8, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmep:15-8
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    References listed on IDEAS

    as
    1. Bassetto, Marco & Phelan, Christopher, 2015. "Speculative runs on interest rate pegs," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 99-114.
    2. Chari, V.V. & Phelan, Christopher, 2014. "On the social usefulness of fractional reserve banking," Journal of Monetary Economics, Elsevier, vol. 65(C), pages 1-13.
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