Reserve Requirements

Reserve requirements are the minimum amount of funds that a bank must hold in reserve, either in cash or as deposits with the central bank. The reserve ratio is the percentage of deposits that must be held in reserve.

Reserve requirements are used to control the money supply and interest rates. When the central bank increases the reserve ratio, it makes it more difficult for banks to lend money, which reduces the money supply and increases interest rates. When the central bank decreases the reserve ratio, it makes it easier for banks to lend money, which increases the money supply and decreases interest rates.

Reserve requirements can also be used to target specific sectors of the economy. For example, the central bank may increase the reserve ratio for banks that lend to businesses, which would make it more difficult for businesses to borrow money and invest.

Reserve requirements are a blunt instrument that can have unintended consequences. For example, when the central bank increases the reserve ratio, it can make it more difficult for banks to meet their reserve requirements, which can lead to a liquidity crisis.

For these reasons, reserve requirements are not used as frequently as they once were. However, they can still be an effective tool for the central bank to use to manage the economy.

In the United States, reserve requirements are set by the Federal Reserve. The reserve ratio is currently 10% for most banks. However, the Federal Reserve can vary the reserve ratio depending on the economic conditions.

Reserve requirements are also used in other countries. For example, the Bank of England sets the reserve ratio for banks in the United Kingdom. The reserve ratio in the United Kingdom is currently 0.5%.