Microsoft Word - Money, Banking, and Int Finance(scribd).docx

Kenneth R. Szulczyk

what the Fed wants. A loan from the Fed is a privilege, and not a right. If a bank needs a loan
from the Fed, and the bank did not do what the Fed wanted, then the Fed could refuse to loan to
the bank. Finally, the Fed uses the discount policy to prevent a financial crisis. The Fed can lend
as much as the banks need. Thus, the Fed calms the financial markets by stating its discount
policy.
Discount policy is not a good tool to control the money supply. For instance, if the Fed
wants to increase the money supply, the Fed must grant more discount loans to banks. However,
the Fed cannot force banks to accept its loans. Then if the Fed pursues contractionary monetary
policy, the Fed must call in loans from the banks, causing hardship. These loans mean banks are
experiencing financial problems, and the Fed could harm them by taking the loans away.
Public and financial analysts scrutinize the federal funds market to predict monetary policy.
For example, when the public and financial analysts see the federal funds interest rate fall, they
infer the Fed is using expansionary policy. On the other hand, if the federal funds rate rises, the
public believes the Fed is using contractionary monetary policy. As you know from this chapter,
the Fed cannot control the federal funds rate, but can only influence it. Other factors can cause
the Federal Funds rate to rise or fall.

Reserve Requirements..........................................................................

Fed can use reserve requirements as a monetary tool. Reserve requirements are the ratio of
reserves to deposits that banks must hold to satisfy depositors’ withdrawals. Banks store
reserves as vault cash or deposits at the Fed. The Fed has the power to set reserve requirements
for banks within the limits set by Congress. The Fed rarely changes the reserve requirements
because changes in the reserve requirements have a significant and disruptive impact on the
banking system. Table 1 shows the current reserve requirements and the date the Fed last
changed them. Consequently, the Fed has not changed reserve requirements since 1990.

Table 1. The Federal Reserve Required Reserve Requirements

Bank liability

Required Reserve

Ratio (%)

Effective date

Checking accounts

$0 to $10.3 million 0 1 - 09 - 90

More than $10.3 million to $44.4 million 3 1 - 09 - 90

More than $44.4 million 10 1 - 09 - 90

Nonpersonal time deposits 0 12 - 27 - 90

The Fed can use reserve requirements to alter the money supply. If the Fed believes banks
are holding too many excess reserves, then banks would create high inflation in the future.