The textbook I’m reading says that the reserve ratio is like the biggest “tool” that the fed has. They are increasing interest rates, but then they are having the reserve ratio at 0% and they are engaging in reverse repo to make sure that banks have plenty of cash. I don’t get it.
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Capital reserve requirements are a much better tool than interest rate hikes to control inflation (growth in the money supply). In effect, they make it more expensive to lend, instead of making it more expensive to borrow. Accomplishes the same effect, while leaving interest rates low(and therefore not punishing those with existing debts)
The reserve ratio is a powerful tool only if banks are bumping against the ratio. Previously, banks kept reserves as low as possible because it tied up money and did not pay any interest. In 2008, new legislation allowed the Fed to start paying interest on reserves. Since they are getting paid a market rate, banks don’t hold the bare minimum. Given that environment, the Fed found that the reserve ratio was not really as powerful as it used to be.
The Fed put the rate at zero in March 2020 (near the peak of the Covid crisis). Many people were hoarding cash, etc. and the Fed didn’t want banks running out of cash and adding to the panic. Fast forward to today, and in the interest the Fed pays on deposits is high (5.4%) so many banks keep cash in reserves just to earn the interest which restricts the money supply.
You are mistaken about the reverse repo portion of this. 1. The Fed **takes** cash and supplies collateral, which is the opposite of what you are stating. 2. Banks don’t use the RRP, since they have the IORB (interest on reserve balances) which is 10 basis points higher. (You can look at historical data on the Fed RRP release page, for any date over 2 months ago and see that banks don’t use it https://imgur.com/a/ogTYAkS)
They had to change it because they dumped $6 trillion into the banking system and then dropped interest rates to 0%. The whole purpose was to get that money flowing since liquidity came to a standstill at lock downs.
Now that interest rates have been jacked up, if they were forced to hold those reserves, they would quickly go broke, paying out deposit interest. Instead, they can deploy that capital, and it incentives them to buy US treasuries. Basically, it added artificial demand to keep the government funded.
Because the banks don’t need bank reserves to lend anymore so it’s meaningless. All of them have learned their Lehman Brothers and Bear Sterns lesson.
The 1950s view of fractional reserve is outdated and is hardly used anymore. Banks use repo (not RRP with the fed) between themselves these days to buy and sell money in wholesale fashion.
Printing money, not printing money… it’s just saber rattling… zero reserve, is a nuclear bomb… Every investment bank on the planet, has more exposure, than currency in the entire world
Your textbook is old and out of date. The reserve ratio has been abandoned as a monetary tool and instead we are using an ample reserves regime.
TLDR we pay banks on their cash instead of requiring them to maintain reserves
Not your question, but how old is your textbook? 1950?
Also: lots of nonsense about “fractional reserve banking” from people who obvioulsy have no clue. Banks don’t “lend out deposits”, this isn’t 1850. When banks lend, they create that money on the spot.
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