Question

What are the reserve requirements according to the Federal Reserve System? How does the Fed use it to fight against the financial crisis? If the required reserve ratio is 8%, how much of a new $15,000 deposit can a bank lend? What is the potential impact on the money supply?

Answer 1

Current reseve requirement of Federal Reserve for US banks is 10%.

This means, banks need to have 10% of total money deposited on reserve.

This ensures that banks will have enough money on hand to prevent them running out of cash in case mass withdrawal happens by customers.

Federal Reserve can use it as its monetary policy in following ways,

1. It can increase its reserve ratio to reduce money supply in the market to reduce inflation.

2. It can decrease its reserve ratio to increase the money supply in the market.

Solution for the problem :

If the bank is depositing $15000, and rrequired reserve ratio is 8%,

then,

Bank needs to have 8% of $15000, i.e. $1200 in its reserves.

Therefore,

Bank can lend,

$15000 - $1200 = $13800.

Due to 8% given reserve criteria, money supply is reduced by 8% in the market.