Question

The year is 2040. The economy of Malta, a small island country in southern Europe, is reaching full employment and experiencing rising inflation. There is a large amount of excess reserves in the banking system. The Maltese central bank hires Zach Johnson, longtime CEO of JP Morgan Chase, as an advisor. What policies, do you think, will Zach recommend in order to prevent the banking system from lending the excess reserves to the public?

Answer 1

In order to prevent the lending of excess reserves by banks to the public, central bank can administer contractionary monetary policy.

Such policy administration will reduce the amount of excess reserves in the banking system and thus prevent the banks from lending the excess reserves to the public.

This policy administration includes the following -

1. Central bank can sell the government bonds. Such selling will reduce or eliminate (depending on the amount of government bonds sold) the excess reserves from the banking syetem.

2. Secondly, central bank can substantially raise the required reserve ratio. This will also drastically reduce the quantity of excess reserves as banks now have to maintain higher levels of required reserves and thus would not be able to lend their excess reserves to the public.