Introduction to Finance

required reserves ratio 
percentage 
of deposits that must be held as 
reserves by a depository institution
excess reserves 
amount by which 
a depository institution’s bank 
reserves are greater than required 
reserves
defi cit reserves 
amount by which 
a depository institution’s bank 
reserves are less than required 
reserves

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C H A PT E R 5 Policy Makers and the Money Supply
excess currency of $100 and deposit it in Bank A. Deposit liabilities and the reserves of Bank 
A are increased by $100. The bank now has excess reserves of $80, assuming a 20 percent 
level of required reserves. These reserves can be used by the banking system to create $400 in 
additional deposits. If the bank does not need the currency but sends it to its Reserve Bank, it 
will receive a $100 credit to its account. The volume of Federal Reserve notes in circulation is 
decreased by $100. These transactions may be summarized as follows:
1.
Deposits in Bank A are increased by $100 ($20 in required reserves and $80 in excess reserves).
2.
Bank A’s deposit at its Reserve Bank is increased by $100.
3.
The amount of Federal Reserve notes is decreased by $100.
The opposite takes place when the public demands additional currency. Let us assume that a 
customer of Bank A needs additional currency and cashes a check for $100. The deposits of 
the bank are reduced by $100, and this reduces required reserves by $20. If the bank has no 
excess reserves, it must take steps to get an additional $80 of reserves by borrowing from its 
Reserve Bank, demanding payment for a loan or not renewing one that comes due or selling 
securities. When the check is cashed, the reserves of the bank are also reduced by $100. If the 
bank has to replenish its supply of currency from its Reserve Bank, its reserve deposits are 
reduced by $100. These transactions may be summarized thus: