Course work in macroeconomics

1.1.2 Change in reserve requirements

         Required reserves are the most liquid assets that all credit institutions are required to have, usually either in the form of cash at the banks ’cash desk, or in the form of deposits with the central bank or in other highly liquid forms determined by the central bank.

         Required reserve ratios are set as a percentage of deposits. They vary in value depending on the types of deposits (for example, on term deposits they are lower than on demand deposits), and also depending on the size of banks (for small banks they are usually lower than for large ones). In modern conditions, required reserves perform not so much the function of deposit insurance (this function is performed by specialized financial institutions, to which banks deduct a certain percentage of deposits), as they serve to carry out the control and regulatory functions of the central bank, as well as for interbank settlements.

         Banks can also store excess reserves - some amounts in excess of required reserves, for example, for unforeseen cases of an increase in the need for liquid funds. However, this deprives banks of the amount of income that they could receive by putting this money into circulation. Therefore, with an increase in the interest rate, the level of excess reserves usually decreases.

1.1.3 Open market operations

Open-market operations consist of the buying of government bonds from, or the selling of government bonds to, commercial banks and the general public. Open market operations are the most important instrument for influencing the money supply.

1.1.4 The reserve ratio

The reserve ratio is the portion of reservable liabilities that commercial banks must hold onto, rather than lend out or invest. This is a requirement determined by the country's central bank, which in the United States is the Federal Reserve. It is also known as the cash reserve ratio.