reserve ratio

Examples of reserve ratio in the following topics:

• The Reserve Ratio

  • The reserve ratio is the percentage of deposits that a bank is required to hold in reserves, or funds that are not allowed to be loaned.
  • The required reserve ratio is a tool in monetary policy, given that changes in the reserve ratio directly impact the amount of loanable funds available .
  • Money growth in the economy can occur through the multiplier effect resulting from the reserve ratio.
  • For example, a reserve ratio of 20% will result in 80% of any given initial deposit being loaned out and if the process of loaning is assumed to continue, the maximum increase in money expansion specific to an initial deposit at a 20% reserve ratio will be equal to the reserve multiplier 1/(reserve ratio) x the initial deposit.
  • For example, with the reserve ratio (RR) of 20 percent, the money multiplier, m, will be calculated as:

• The Fractional Reserve System

  • The fraction of deposits that a bank must hold as reserves rather than loan out is called the reserve ratio (or the reserve requirement) and is set by the Federal Reserve.
  • Excess reserves plus required reserves equal total reserves.
  • First, it can adjust the reserve ratio.
  • A lower reserve ratio means that banks can issue more loans, increasing the money supply.
  • Creating reserves means that commercial banks have more reserves with which they can satisfy the reserve ratio requirement, leading to more loans and an increase in the money supply.

• The Money Multiplier in Theory

  • That is, in a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) is a multiple of reserves; this multiple is the reciprocal of the reserve ratio.
  • We can derive the money multiplier mathematically, writing M for commercial bank money (loans), R for reserves (central bank money), and RR for the reserve ratio.
  • We start with the reserve ratio requirement that the the fraction of deposits that a bank keeps as reserves is at least the reserve ratio:
  • The above equation states that the total supply of commercial bank money is, at most, the amount of reserves times the reciprocal of the reserve ratio (the money multiplier) .
  • A 10% reserve requirement creates a total money supply equal to 10 times the amount of reserves in the economy; a 20% reserve requirement creates a total money supply equal to five times the amount of reserves in the economy.

• Example Transactions Showing How a Bank Can Create Money

  • When a bank's excess reserves equal zero, it is loaned up.
  • The deposit multiplier is the ratio of the maximum possible change in deposits to the change in reserves.
  • When banks in the economy have made the maximum legal amount of loans (zero excess reserves), the deposit multiplier is equal to the reciprocal of the required reserve ratio ($m=1/rr$).
  • Thus, with a required reserve ratio of 0.1, an increase in reserves of $1 can increase the money supply by up to $10 .
  • Calculate the change in money supply given the money multiplier, an initial deposit and the reserve ratio

• The Federal Funds Rate

  • The Federal Funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve.
  • In the US, banks are obligated to maintain certain levels of reserves, either in the form of reserves with the Fed or as vault cash.
  • These daily activities change their ratio of reserves to liabilities.
  • If, by the end of the day, the bank's reserve ratio has dropped below the legally required minimum, it must add to its reserves in order to remain compliant with the law.
  • Banks do this by borrowing reserves from other banks with excess reserves, and the weighted average of these interest rates paid by borrowing banks determines the federal funds rate.

• The Money Multiplier in Reality

  • First, some banks may choose to hold excess reserves.
  • During this time, the relationship between reserves, reserve requirements, and the money supply was relatively close to that predicted by economic theory.
  • The presence of these excess reserves suggests that the reserve requirement ratio is not exerting an influence on the money supply.
  • Imagine that the reserve requirement ratio is 10% and a customer deposits $1,000 into a bank.
  • After the financial crisis the monetary base increased dramatically: the result of banks starting to hold excess reserves as well as the central bank increasing the supply of reserves.

• Managing the Business Cycle

  • Expansionary monetary policy relies on the central bank increasing availability of loanable funds through three mechanisms: open market operations, discount rate, and the reserve ratio.

• Setting and Achieving the Interest Rate Target

  • The Federal Reserve (Fed) has an ability to directly influence economic growth and stability through the use of monetary policy.
  • The Federal Reserve (Fed) has an ability to directly influence economic growth and stability through the use of monetary policy.
  • The Fed can set a reserve ratio, which is in effect the required reserves (percentage of deposits) that a bank must hold either on site or at the Fed.
  • For banks in need of reserve funds, the overnight or short-term bank loan market is available.
  • Describe the way in which the Federal Reserve targets the interest rate

• Voluntary Exchange

  • The maximum price the buyer is willing and able to pay for a good is called the "reservation price of the buyer (RPB)" and the minimum price the seller will accept for the good is the "reservation price of the seller (RPS)."
  • Neither the buyer nor seller wants the other party to know their reservation price.
  • The ratio at which cola and tea trade can be called the exchange ratio.
  • The exchange ratio is the price of one good in terms of another.
  • The relative prices of cola and tea are established by the exchange ratio.

• Structure of the Federal Reserve

  • The Federal Reserve (the Fed) was designed to be independent of the Congress and the government.
  • The Federal Open Market Committee (FOMC), composed of the seven members of the Federal Reserve Board and five of the 12 Federal Reserve Bank presidents, which oversees open market operations, the principal tool of U.S. monetary policy.
  • Twelve regional Federal Reserve Banks located in major cities throughout the nation, which divide the nation into twelve Federal Reserve districts.
  • The Federal Reserve Banks act as fiscal agents for the U.S.
  • Recall the structure of the Federal Reserve System of the United States