Excess Reserves

Definition

Excess reserves refer to the amount of funds that banks hold in their accounts with the central bank that exceeds the minimum reserve requirement. These excess funds can be used by banks to extend more loans and increase the money supply in the economy.

5 Must Know Facts For Your Next Test

1. Excess reserves provide banks with the ability to increase lending and expand the money supply, which can have implications for inflation and economic growth.
2. The level of excess reserves held by banks is influenced by factors such as the central bank's monetary policy, the demand for loans, and the risk appetite of banks.
3. During periods of economic uncertainty or financial stress, banks may choose to hold higher levels of excess reserves as a precautionary measure, limiting their lending activities.
4. Excess reserves can be used by banks to meet unexpected withdrawals or to take advantage of investment opportunities, such as purchasing government securities.
5. Central banks can influence the level of excess reserves by adjusting the reserve requirement or by implementing policies that affect the availability of reserves in the banking system.

Review Questions

• Explain how excess reserves can impact the money supply and the economy.
  • Excess reserves provide banks with the ability to expand their lending activities, which can lead to an increase in the money supply. When banks lend out their excess reserves, it creates new deposits, allowing for the money multiplier effect to take place. This expansion of the money supply can have implications for inflation, economic growth, and the overall stability of the financial system. The level of excess reserves held by banks is a key factor in determining the potential for monetary expansion and the effectiveness of the central bank's monetary policy.
• Describe the relationship between excess reserves, the reserve requirement, and fractional reserve banking.
  • Excess reserves are directly related to the reserve requirement and the fractional reserve banking system. The reserve requirement sets the minimum amount of deposits that banks must hold as reserves, while the remaining portion can be lent out. Excess reserves refer to the funds held by banks that exceed this minimum requirement. In a fractional reserve banking system, banks can use their excess reserves to create new loans, which in turn generate new deposits, allowing for an expansion of the money supply. The level of excess reserves held by banks is a key determinant of the money multiplier and the potential for monetary expansion in the economy.
• Analyze the factors that influence the level of excess reserves held by banks and how this can affect the central bank's monetary policy objectives.
  • The level of excess reserves held by banks is influenced by a variety of factors, including the central bank's monetary policy, the demand for loans, and the risk appetite of banks. During periods of economic uncertainty or financial stress, banks may choose to hold higher levels of excess reserves as a precautionary measure, limiting their lending activities and reducing the effectiveness of the central bank's expansionary monetary policies. Conversely, when banks have ample excess reserves, they may be more inclined to lend, leading to an expansion of the money supply and potentially higher inflation. Central banks can influence the level of excess reserves by adjusting the reserve requirement or by implementing policies that affect the availability of reserves in the banking system, in an effort to achieve their monetary policy objectives.

Related terms

Reserve Requirement:

The minimum amount of funds that banks must hold in their accounts with the central bank, usually expressed as a percentage of their total deposits.

Money Multiplier:

The concept that banks can use their excess reserves to create new loans, which in turn generate new deposits, allowing for an expansion of the money supply.

Fractional Reserve Banking:

The banking system where banks are required to hold only a fraction of their deposits as reserves, allowing them to lend out the remaining portion and create new money.