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Monetary policy without reserve requirements: analytical issues

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  • Gordon H. Sellon
  • Stuart E. Weiner

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.

Suggested Citation

  • Gordon H. Sellon & Stuart E. Weiner, 1996. "Monetary policy without reserve requirements: analytical issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 5-24.
  • Handle: RePEc:fip:fedker:y:1996:i:qiv:p:5-24:n:v.81no.4
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    References listed on IDEAS

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    1. Stuart E. Weiner, 1992. "The changing role of reserve requirements in monetary policy," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 45-63.
    2. Joshua N. Feinman, 1993. "Reserve requirements: history, current practice, and potential reform," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jun, pages 569-589.
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    Cited by:

    1. Craig Furfine, 1998. "Interbank payments and the daily federal funds rate," Finance and Economics Discussion Series 1998-31, Board of Governors of the Federal Reserve System (U.S.).
    2. Nada Mora, 2014. "Reason for Reserve? Reserve Requirements and Credit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(2-3), pages 469-501, March.
    3. George A. Kahn & Klara Parrish, 1998. "Conducting monetary policy with inflation targets," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-32.
    4. Michael Woodford, 2001. "Monetary policy in the information economy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 297-370.
    5. Schreft, Stacey L. & Smith, Bruce D., 2000. "The evolution of cash transactions: Some implications for monetary policy," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 97-120, August.
    6. Sánchez-Fung, José R., 2008. "The day-to-day interbank market, volatility, and central bank intervention in a developing economy," MPRA Paper 15648, University Library of Munich, Germany.
    7. Mauricio Avella Gómez, 2007. "El Encaje Bancario en Colombia Perspectiva General," BORRADORES DE ECONOMIA 004327, BANCO DE LA REPÚBLICA.
    8. Katherine Avram, 1998. "Implications Of New Payments Technology For Monetary Policy," Economic Papers, The Economic Society of Australia, vol. 17(4), pages 54-68, December.
    9. Di Giorgio, Giorgio, 1999. "Financial development and reserve requirements," Journal of Banking & Finance, Elsevier, vol. 23(7), pages 1031-1041, July.
    10. Li Ma & Tsangyao Chang & Chien-Chiang Lee, 2016. "Reserve Requirement Policy, Bond Market, and Transmission Effect," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 66-85, June.
    11. Cover, James P. & VanHoose, David D., 2000. "Political pressures and the choice of the optimal monetary policy instrument," Journal of Economics and Business, Elsevier, vol. 52(4), pages 325-341.
    12. James A. Clouse & Douglas W. Elmendorf, 1997. "Declining required reserves and the volatility of the federal funds rate," Finance and Economics Discussion Series 1997-30, Board of Governors of the Federal Reserve System (U.S.).
    13. TUYSUZ, Sukriye, 2007. "Central Bank transparency and the U.S. interest rates level and volatility response to U.S. news," MPRA Paper 5217, University Library of Munich, Germany.
    14. Philip Arestis & Panicos Demetriades & Bassam Fattouh, 2003. "Financial Policies and the Aggregate Productivity of the Capital Stock: Evidence from Developed and Developing Economies," Eastern Economic Journal, Eastern Economic Association, vol. 29(2), pages 217-242, Spring.
    15. VanHoose, David D. & Humphrey, David B., 2001. "Sweep accounts, reserve management, and interest rate volatility1," Journal of Economics and Business, Elsevier, vol. 53(4), pages 387-404.
    16. Bental, Benjamin & Eden, Benjamin, 2002. "Reserve requirements and output fluctuations," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1597-1620, November.
    17. Woodford, Michael, 2000. "Monetary Policy in a World without Money," International Finance, Wiley Blackwell, vol. 3(2), pages 229-260, July.
    18. Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October.
    19. Rodrigo Cifuentes S., 2001. "Encaje a los Depósitos: Argumentos Teóricos e Impcato en la Política de Liquidez de los Bancos," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 4(3), pages 97-101, December.
    20. Kopecky, Kenneth J. & VanHoose, David, 2004. "Bank capital requirements and the monetary transmission mechanism," Journal of Macroeconomics, Elsevier, vol. 26(3), pages 443-464, September.
    21. Mauricio Avella Gómez, 2007. "El encaje bancario en Colombia Perspectiva general," Borradores de Economia 470, Banco de la Republica de Colombia.
    22. Tuysuz, Sukriye, 2007. "The asymmetric impact of macroeconomic announcements on U.S. Government bond rate level and volatility," MPRA Paper 5381, University Library of Munich, Germany.
    23. Demiralp, Selva & Farley, Dennis, 2005. "Declining required reserves, funds rate volatility, and open market operations," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1131-1152, May.
    24. Nicolas Couderc, 2005. "Réserves obligatoires : un état des lieux," Revue d'Économie Financière, Programme National Persée, vol. 78(1), pages 363-380.
    25. Haydn Davies, 1998. "Averaging in a framework of zero reserve requirements: implications for the operation of monetary policy," Bank of England working papers 84, Bank of England.

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    Keywords

    Monetary policy ; Bank reserves;

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