Question

What are the benefits and opportunity costs to a bank that maintains a consistent level of excess reserves?

Answer 1

1 ) A central bank may choose to maintain a high level of reserve balances in normal times because doing so offers some important advantages, particularly for the operation of the payments system.

2 ) The liquidity facilities and other credit programs introduced by the Federal Reserve in response to deal with situations like the crisis have created, as a by-product, a large quantity of reserves in the banking system.

3) A large quanty of reserves in the banking system. Second, we showed that while the lending decisions and other activities of banks may result in small changes in the level of required reserves, the vast majority of the newly created reserves will end up being held as excess reserves.

4 ) Paying interest on reserves allows a central bank to maintain its infl uence over market interest rates irrespective of the quantity of reserves in the banking system.

5 ) The central bank can then scale its policy initiatives according to conditions in the fi nancial sector, while setting its target for the short-term interest rate in response to macroeconomic conditions.

6 ) Central bank sets it's target in short term interest rate in response to macroeconomic conditions. This ability to separate short-term interest rates from the quantity of reserves is particularly important during the recovery from a fi nancial crisis. If infl ationary pressures begin to appear while the crisis-related programs are still in place, the central bank can use its interest-on-reserves policy to raise interest rates without necessarily removing all of the newly created reserves