Zemlyanko K.O.
PhD Zhukova O.S.
PhD Petrachkova O.L.
Donetsk State University of Management
RESERVE REQUIREMENT
A
banker would like his money holdings to be reduced to a minimum, since they
produce no income.
But
there is always an important reason for the banker to hold his money balances
at a certain level. The Central Bank makes him hold a certain share of his
total balances in reserve. These reserve balances must be in the form of cash
or of deposits made by commercial banks with a certain authorized bank. Most of
reserve balances are known to be in the form of deposits. Setting the reserve
requirements, the Central Bank can regulate money circulation and money supply
in an economy.
The
Central Bank can, on the one the one hand, increase commercical banks’ reserves
by direct intervention. One way of doing this is by the so-called open market
operations: it buys government bonds from the public; thus, the money that goes
to the public in payment for these bonds will eventually be deposited with
commercial banks, most likely in interest- earning deposits. Having been
deposited with a bank, money stops being money, but it represents a net
addition to reserve balances capable of supporting loan transactions several
times their own value. For this reason, the Central Bank is said to have
supplied “high powered” money to commercial banks.
On the
other hand, selling bonds to the public, the Bank can reduce the banking
system’s reserves and thus make the money supply reduce.
Open
market operations are not the only method of direct reserve intervention.
Another way for the Central Bank to increase money in circulation is to make
loans to commercial banks who in turn lend out to the public the money to be
used for daily expenditure.
Finally,
the Central Bank can change the money supply without affecting the amount of
reserves to be held by commercial banks. It can do this simply having changed
the reserve requirement. Having been decreased from 20 percent to 10 percent,
the reserve balances will actually double their capacity to support
transactions. As a result, maintaining the same reserve balances, banks get a
change of handling loan transactions twice as large as before.
Thus,
the three monetary policies a Central Bank can implement are as follows:
1. Open
market operations.
2.
Loans to commercial banks.
3.
Changes in reserve requirements.
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