Question

(1) Discuss the Federal Reserve’s ability to control the amount of money created in the banking system by changing the reserve requirements. (2) What will happen to the Reserve’s ability to control money creation if banks increase or start holding excess reserves?

Answer 1

Ans 1. The Federal Reserve can control the amount of money created in the banking system by changing the reserve requirements i.e. by lowering the bank's reserve requirements , banks are able to give more loan since it increases the overall supply of money in the economy whereas by raising the bank's reserve requirements , banks are able to give less loan since the federal reserve is able to decrease the supply of money in the economy .

Ans 2. If the banks start holding excess reserves than Federal reserve will control the money creation in the economy through the Interest on excess reserve rate (IOER) in which the Federal reserve will provide interest on excess reserve to banks thus providing the banks an incentive to hold excess reserve and decreasing the money supply in the economy by discouraging the banks to lend money to borrowers .