Reserve Requirements and Economic Stability

Abstract

RESERVE REQUIREMENTS HAVE BECOME a common institutional feature of our monetary systems. They are widely held to be indispensable for zfficient control of the financial sector of the economy. Yet, relatively little analysis has been directed at the question of what constitutes an optimal level and structure of reserve requirements. In the traditional literature, the major exceptions concetn some discussions of the extreme values of 100 percent or zero requirements, especially the former (see, e.g., [1, 5, 6, 7, 10]). For a zero required reserve proposal, see [3]. In recent years, some newer studies dealing with these issues have appeared (see, e.g., [8, 9, 11, 12, 15]). In all of these studies, the focus is almost exclusively on money stock control. Generally speaking, their results support the 100 percent reserves idea, though such a scheme is usually seen as infeasible for political or institutional reasons, leading to recommendations to set requirements as high as possible against deposits included in the money stock, subject to whatever constraints of this nature are perceived. The underlying idea, of course, is that this minimizes the influence of private sector disturbances on the money stock by lowering the money multiplier (and making it equal to one in the extreme case of a 100 percent requirement). Reserve requirements are comparable to a tax on a particular economic activity, namely, the production of deposit accounts. As such, they have efficiency effects similar to those of a tax on other types of activities. Although this has always been