Monetary base is defined as currency+currency held by banks+deposits of banks at central bank. We assume that the current reserve is below the minimum reserve requirement. Which component of monetary base is affected? Please note the distinction between money supply and monetary base.

  • $\begingroup$ Since the financial crisis, in the US the monetary base has exploded, mainly because commercial banks hold much more as reserves in the FED that they are required to, so minimum reserve requirements have no impact $\endgroup$ – Henry Feb 5 at 0:24
  • $\begingroup$ Much the same elsewhere, for example in Switzerland and the UK $\endgroup$ – Henry Feb 5 at 0:28
  • $\begingroup$ What if the reserve is below the minimum reserve requirement (a counterfactual question)? $\endgroup$ – Alex Wang Feb 5 at 14:30

In a fractional reserve banking system, the maximum portion of the money supply represented by bank-issued loans relates to the reserve requirement as $M_{loans} = \frac{deposits}{r} - deposits$ where $r$ is the reserve requirement expressed as a decimal.

For example, a bank holding \$1000 in deposit liabilities facing a reserve requirement of 1% is free to issue $\$1000/.01 - \$1000 = \$99,000$ in new money in the form of loans. Doubling the reserve requirement to 2% would reduce this number to $\$49,000$.

Reserve requirements in the US depend on the total amount held by a given bank and range from 0% to 10%, with larger banks facing the larger requirement. https://www.federalreserve.gov/monetarypolicy/reservereq.htm. Some countries, like Canada, do not have a reserve requirement. Banks determine their reserves according to their internal risk models, including assumptions on inflation risk.

Of course, banks don't have to lend money out until they hit the reserve requirement, and as noted in comments above, the money supply in the US is largely decoupled from banking operations thanks to quantitative easing measures.

| improve this answer | |
  • $\begingroup$ So the monetary base will increase right? Which component of it is increasing? $\endgroup$ – Alex Wang Feb 5 at 19:01
  • $\begingroup$ In your original question you wrote "currency+currency held by banks+deposits of banks at central bank". The part that would increase due to creation of loans is "currency", e.g., currency in circulation. $\endgroup$ – heh Feb 5 at 19:52

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.