Introduction to Finance

FIGURE 5.2
 Transactions 
Aff ecting Bank Reserves
Nonbank Public
Federal Reserve System
U.S. Treasury
Change in the non-bank public’s 
demand for currency to be 
held outside the banking 
system
Change in required reserves ratio
Open-market operations
(buying and selling government
and other securities)
Change in bank borrowings
Change in float
Change in foreign deposits
held in Reserve Banks
Change in other Federal
Reserve 
accounts
Change in Treasury
spending out of accounts 
held at Reserve Banks
Change in Treasury
cash 
holdings

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5.7 Factors Aff ecting Bank Reserves
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a given volume of reserves. Such transactions are initiated by the Fed when it buys or sells 
securities, by a depository institution when it borrows from its Reserve Bank, or by a change 
in Federal Reserve fl oat. These are examined here in turn, and then the eff ect of a change in 
reserve requirements is described. Finally, we will look at Treasury transactions, which can 
also aff ect reserves in the banking system.
Open-Market Operations 
When the Fed, through its open-market operations, pur-
chases securities such as government bonds it adds to bank reserves. The Fed pays for the 
bonds with a check. The seller deposits the check in an account and receives a deposit account 
credit. The bank presents the check to the Reserve Bank for payment and receives a credit to 
its account. When the Fed buys a $1,000 government bond, the check for which is deposited 
in Bank A, the transactions may be summarized, as follows:
1.
Bank A’s deposit at its Reserve Bank is increased by $1,000. The Reserve Bank has a new 
asset—a bond worth $1,000.
2.
Deposits in Bank A are increased by $1,000 ($200 in required reserves and $800 in excess 
reserves).
The opposite takes place when the Fed sells securities in the market.
In contrast to the other actions that aff ect reserves in the banking system, open-market oper-
ations are entirely conducted by the Fed. For this reason, they are the most important policy tool 
the Fed has to control reserves and the money supply. Open-market operations are conducted 
virtually every business day, both to smooth out ups and downs caused by other transactions and 
to implement changes in the money supply called for by the Federal Open Market Committee.