When the required reserve ratio is increased, the excess reserves of member banks are:

When the required reserve ratio is increased, the excess reserves of member banksare:Select one:a. reduced, but the multiple by which the commercial banking system canlend is unaffected.

b. reduced and the multiple by which the commercial banking system canlend is increased.c. increased and the multiple by which the commercial banking systemcan lend is increased.•d. reduced and the multiple by which the commercial banking system canlend is reduced../The correct answer is: reduced and the multiple by which the commercial bankingsystem can lend is reduced.

Question14Correct2.00 points outof 2.00(1)(1)(3)InterMtn e.dmtn4%$'100$8059076807708604Refer to the above table, in which investment is in billions. Suppose the Fed reducesthe interest rate from 6 percent to 5 percent. Given columns (1) and (2), investmentwill:Select one:t060500�

Question15Inflation targeting consists of the Fed:Select one:Correct2.00 points out

of 2.00b. using monetary policy to hold the price of a fixed basket ofcommodities (wheat, gold, pork, and so on) to a 1 to 2 percent annualincrease.c. identifying the sources of inflation and recommending structuralchanges in the economy that would relieve upward price pressures.•d. regularly stating an explicit goal for the rate of inflation over somefuture period, such as the following two years.�The correct answer is: regularly stating an explicit goal for the rate of inflation oversome future period, such as the following two years.

Question16Correct2.00 points outof 2.00

Anytime a bank keeps more money on hand than is required by regulation, it is known to have excess reserves. Banks typically hold excess reserves in times of financial uncertainty or if they believe interest rates will fall.

Here’s a closer look at how excess reserves work, why they are held, and what they mean for you as a banking customer.

Definition and Examples of Excess Reserves

Excess reserves refer to the surplus of cash a bank holds in its vault or Fed account beyond what is required by the Federal Reserve to be on hand.

Note

The Federal Reserve, or Fed, is the U.S. central bank in charge of managing the money supply and interest rates in the country. It has many tools at its disposal to do this job. One such tool is changing the amount of money commercial banks must keep on reserve.

For example, suppose a bank is required to keep 10% of its deposits in reserve. If a bank has 12% in its reserve, then it has an excess reserve of 2%. The bank is free to use these funds for any purpose.

How Do Excess Reserves Work?

Banks make money by taking in deposits from customers, then lending that money back out to others at a higher interest rate. They can’t lend out all their money, though, because they need liquid cash on hand to pay their bills and fulfill withdrawal requests from customers.

The Federal Reserve tells depository institutions the minimum amount of money they must keep available for financial obligations. This minimum is known as the reserve requirement. Any money banks keep over this limit is considered excess reserves.

Banks don’t lend excess reserves to businesses or consumers. Rather, they hang onto them in case of emergency.

The excess reserves formula looks like this:

Excess Reserves = Total Reserves - Required Reserves

In essence, a bank’s excess reserves are any cash it keeps over the required minimum. For example, suppose a bank has $20 million in deposits. If its reserve ratio is 10%, then it’s required to keep at least $2 million on hand. However, if the bank has $3 million in reserves, then $1 million of it is in excess reserves.

On the other hand, if a bank has $2 million in reserves and is required to keep $2 million on hand, then it has zero excess reserves.

Why Do Banks Hold Excess Reserves?

You may be wondering “What’s the significance of excess reserves? Why do banks use them?” At their core, excess reserves act as a safety net for banks during times of economic uncertainty. The bank can fall back on this buffer if loans default or a lot of customers withdraw money at once.

Think of it like this: If you knew a hurricane was headed your way, you’d stock up at the grocery store and fill your pantry with all types of necessities to prepare for the unexpected. Banks do the same thing when they hold excess reserves.

Note

Excess reserves in the U.S. doubled early in the pandemic, soaring from $1.5 trillion in February 2020 to $3.2 trillion in May 2020. This is a prime example of how banks prepared for the financial uncertainty of the sweeping event.

As a banking customer, you usually don’t know when your institution has excess reserves. All you know is that you can withdraw or transfer money whenever you need it. In a sense, this is what having excess reserves is all about—making sure you always have a smooth banking experience, no matter what’s going on in the world.

Required Reserves vs. Excess Reserves

Banks must keep a certain percentage of their deposits on reserve in a vault or with their local Federal Reserve branch. This minimum is the required reserve. If the bank chooses to hold onto additional money over this threshold, then it has excess reserves.

Just as you earn interest on your savings account balance, banks also earn interest on their required reserves and excess reserves. The Federal Reserve sets these interest rates.

Key Takeaways

• Excess reserves are the additional amount of money a bank keeps on hand over the reserve requirement.
• Excess reserves are important because they act as a safety net during times of economic uncertainty, ensuring the bank has enough money on hand to pay bills and honor withdrawals.
• You can calculate excess reserves by subtracting a bank’s required reserves from its total reserves.

What happens to the excess reserves of member banks when the reserve requirement is raised?

When the required reserve ratio is increased the excess reserves of commercial banks are?

What happens when banks increase excess reserves?

What happens when the required reserve ratio is increased?