The purpose of this research is to examine the issue of reserve requirements mandated by the Federal Reserve System and their impact on monetary policy. The plan of the research will be to set forth the relevance of reserve requirements to money and financial markets and to discuss the logical and substantive strengths and weaknesses of various treatments of the subject.
"Fedpoint 45: Reserve Requirements," a publication of the New York Federal Reserve Bank, presents a straightforward description and explanation of funds that, as the term implies, banks are obliged to keep in reserve, i.e., unavailable for lending or investment. The relevance of reserve requirements to money and financial markets, from the point of view of the finan cial institutions, is that the reserve requirements represent an opportunity cost to the banks inasmuch as those funds that might be used for lending or investment are not available to the banks but must lie idle "as vault cash or on deposit at a Federal Re serve Bank" (FRBNY, 1997, p. 1). The reserve requirements are also a real cost to the banking system inasmuch banks must forgo the beneficial use of reserved funds for other profit-making pur poses. On the other hand, reserve requirements can be viewed as a leverage against risk of absolute insolvency, a cushion of cash in the event of financial emergency. The reserve requirements are relevant to money and financial markets from the point of view of the Fed, inasmuch as the reserves "are used in the day-to-day implementation of monetary policy" (FRBNY, 1997, p. 1).
The amount of required reserves is set by law, notably the Monetary Control Act of 1980 (FRBNY, 1997, p. 1), and require ments vary with the category of bank funds. For example, reserve requirements apply to transaction accounts (i.e., demand depos its), which comprise M1 or the money supply available for buying and selling goods and services, but not to savings accounts or time deposits...