Effects On Money Supply
The reserve requirement can be used as an instrument of monetary policy, because the higher the reserve requirement is set, the less funds banks will have to loan out, leading to lower money creation and perhaps ultimately to higher purchasing power of the money previously in use. The effect is multiplied, because money obtained as loan proceeds can be re-deposited; a portion of those deposits may again be loaned out, and so on. The effect on the money supply is governed by the following formulas:
- : definitional relationship between monetary base Mb (bank reserves plus currency held by the non-bank public) and the narrowly defined money supply, M1,
- : derived formula for the money multiplier mm, the factor by which lending and re-lending leads M1 to be a multiple of the monetary base,
where notationally,
- the currency ratio: the ratio of the public's holdings of currency (undeposited cash) to the public's holdings of demand deposits; and
- the total reserve ratio ( the ratio of legally required plus non-required reserve holdings of banks to demand deposit liabilities of banks).
However, in the United States (and other countries except Brazil, China, India, Russia), the reserve requirements are generally not frequently altered to implement monetary policy because of the short-term disruptive effect on financial markets.
Read more about this topic: Reserve Requirement
Famous quotes containing the words effects, money and/or supply:
“The best road to correct reasoning is by physical science; the way to trace effects to causes is through physical science; the only corrective, therefore, of superstition is physical science.”
—Frances Wright (1795–1852)
“Don’t want no money from you Ethan, no money, Marty. Just a roof over old Mose head and a rocking chair by the fire, my own rocking chair by the fire.”
—Frank S. Nugent (1908–1965)
“Has God’s supply of tolerable husbands
Fallen, in fact, so low?
Or do I always over-value woman
At the expense of man?
Do I?
It might be so.”
—Robert Graves (1895–1985)