In March 2020, the Fed set the reserve ratio to 0% in response to the pandemic. Why haven't they put the reserve requirements back in place since then?
They've already started targeting higher interest rates. Raising the reserve ratio would serve the same purpose as raising interest rates as far as combatting inflation goes.
If I had to make a guess, is it because the move would be seen as futile? Eyeballing this graph from the St. Louis Fed, the in aggregate, the reserves seem to be 10% - 20% even with a 0% reserve requirement. Putting the reserve ratio back to 3% - 10% wouldn't reduce the money supply as much as it could if excess reserves were lower. Also, maybe raising the reserve ratio is seen as a much weaker move than just increasing the interest rate on excess reserves which is has gone from < 1% to almost 5% over the last year or so. Is the reserve ratio seen as an outdated tool that may not be useful given everything else nowadays?
Why hasn't the Fed put the reserve requirements back in place?
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Re: Why hasn't the Fed put the reserve requirements back in place?
The reserve ratio only applies to "checking" accounts. It's there to avoid infinite leverage which is a problem on bankruns. However, most credit that is made out of thin air is longer term debt (business loans) and they don't have the risk of bank runs. So in a sense, the reserve ratio is outdated.
I think more interestingly, the yield on bank CDs is slightly BELOW the FOMC rate (inverted yield curve), indicating that banks aren't really interested in more cash. They have nowhere to put it. All we can do is way for interest payments (back to the CBs) to suck credit out of the system.
I think more interestingly, the yield on bank CDs is slightly BELOW the FOMC rate (inverted yield curve), indicating that banks aren't really interested in more cash. They have nowhere to put it. All we can do is way for interest payments (back to the CBs) to suck credit out of the system.
Re: Why hasn't the Fed put the reserve requirements back in place?
Two more reasons: of all "traditional" monetary policy tools (open market operations, fiddling with interest rates, fiddling with the reserve requirement), the reserve requirement works the slowest. It simply takes A Long Time for any RR effect on M1 to be felt compared to the other 2 methods.
Second, currently, the Fed pays banks interest on their reserve balances. This is a new thing, and what it does is, it disinsentivizes lending to consumers by providing an income-generating option for banks' cash that's always available, is frictionless, and doesn't have administrative costs. A simple made-up example: if the Fed will pay you 4% to keep your reserves in your account at the FED, you will not incur the costs to evaluate the creditworthiness of Joe Schmo, take the same cash, divide it over 10,000 Joe Schmoes, and administering 4.5 - 5% loans to all of them. Banks would now lend to the general economy only if it's substantially profitable (they will still leng to large corporations with good credit standing e.g. Apple and the like, which absorb a lot of cash at once, but not so much to small businesses and individuals).
Second, currently, the Fed pays banks interest on their reserve balances. This is a new thing, and what it does is, it disinsentivizes lending to consumers by providing an income-generating option for banks' cash that's always available, is frictionless, and doesn't have administrative costs. A simple made-up example: if the Fed will pay you 4% to keep your reserves in your account at the FED, you will not incur the costs to evaluate the creditworthiness of Joe Schmo, take the same cash, divide it over 10,000 Joe Schmoes, and administering 4.5 - 5% loans to all of them. Banks would now lend to the general economy only if it's substantially profitable (they will still leng to large corporations with good credit standing e.g. Apple and the like, which absorb a lot of cash at once, but not so much to small businesses and individuals).