Ratio of rate and deposit on options
What effect does a change in the reserve requirement ratio have on the money supply? August 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 effect does a change in the reserve requirement ratio have on the money supply?
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.
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Reserve Requirement Changes Affect the Money Stock Purpose and Functions describes how a change in the reserve requirement ratio affects bank credit and the money stock. 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. 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.
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. 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. Endnotes 1.
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The third monetary policy tool is the discount rate, the interest rate charged when depository institutions borrow overnight from the Federal Reserve discount window.
The Ratio of rate and deposit on options Control Act of sets the statutory requirements for reserves. Net transaction accounts include checking accounts demand depositsNOW accounts, and share drafts.
In a fractional reserve system, banks are only required to hold reserves against a fraction of their deposits.
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For additional detail, see the H. See Financial and Business Statistics. Table 1.
Money Stock and Debt Measures.