Question

If net borrowed reserve balances are excessively negative, what would this imply for commercial banks? What can the FED do to alleviate this problem? Use the monetary-sector equilibrium model to analyze the consequences of your chosen policy on equilibrium conditions in the financial market (do not forget to talk about how the money multiplier would change in response to your policy recommendation).

Answer 1

Net borrowed reserve = (Cash reserves the bank hold above minimum - Borrowed funds from Fed)

This number is expressed as a negative number.

If this is excessively negative, that means borrowed funds from fed is very high and cash reserves are very low.

Cash reserves are low when banks lend more.

To solve such problem, Fed may follow an expansionary monetary policy by reducing the reserve requirement.

Reduction in reserve requirement increase the amount of money created.

Money multiplier is 1/(reserve requirement)

if reserve requirement goes down, money mulitplier goes up and liquidity in the market goes up as well.