Chapter 15.2, Problem 3R

To determine

To evaluate: The reason for the government require banks to keep reserves.

Explanation of Solution

Reserve requirements are the amount of cash that banks can have, in compliance with the deposits of their customers, at the nearest Federal Reserve Bank or in their vaults. Reserve conditions are one of the three primary monetary policy instruments set by the Fed governors, while the other two are the discount rate and open market operations.

For example, one could assume that a bank has $200 million in deposits and is needed to retain 10 percent. Now the bank is able to lend $180 million which raises bank credit considerably. The Federal Reserve frequently utilizes reserve criteria as a monetary instrument, in addition to providing a buffer against bank runs and a layer of liquidity.