Reserve requirements, imposed by the FEDERAL RESERVE SYSTEM, mandate that commercial banks and other depository institutions keep a certain percentage of their deposits in accounts with the Federal Reserve Bank (the central bank in the United States, known as the Fed) or as cash in their vaults. Reserve requirements ensure liquidity in the BANKING SYSTEM and allow the Fed to exercise greater control over the MONEY SUPPLY. Along with changes in the DISCOUNT RATE and OPENMARKET OPERATIONS, changes in the reserve requirements comprise one of the major tools used in MONETARY POLICY, whose goals are ECONOMIC GROWTH and price stability, with primary emphasis on price stability. By changing the percentage of deposits banks must keep in their vault or on deposit, the Fed can influence the ability of banks to make LOANS and in the process create MONEY in the economy. An increase in the reserve requirement will reduce the money supply, while a decrease will allow expansion of the money supply. The Federal Reserve was first given authority to change reserve requirements in the 1930s. During the GREAT DEPRESSION, many U.S. banks, alarmed by “runs” (large numbers of customers demanding their deposits back), increased their holdings of excess reserves. Fearing banks would lend out these excess reserves and create an uncontrollable expansion of the money supply, the Fed raised reserve requirements three times in 1936 and 1937. This resulted in a slowdown in the growth of the money supply, increasing INTEREST RATES and contributing to the RECESSION of 1937–38. Since then, the Fed has made much more limited use of changing reserve requirements as a policy tool. As of 1999 all depository institutions were subject to the following reserve requirements.
• 3 percent on the bank’s first $44.3 million of checkable deposits
• 10 percent on checkable deposits greater than $44.3 million
Checkable deposits include noninterest-bearing checking accounts, NOW accounts, super-NOW accounts, and automatic transfer savings accounts. The Fed has authority to change the 10-percent requirement in a range of 8–14 percent, and in extraordinary conditions it could be raised as high as 18 percent.