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Unformatted text preview: se the size of an institution's reserve requirement determines the number of dollars that it can create per dollar of reserves. A shift of reserves from an institution with high reserve requirements to another with lower 2-28 Licensing School for Appraisal, CPA, Contractors, Insurance, Real Estate, Notary, Nurse, Food Handlers, Tax and Securities 2. THE MONEY MARKET
requirements, for example, increases the banking system's capacity to produce deposits even though total reserves are unchanged. In practice, the Trading Desk is generally able to deal with these problems by varying the total stock of reserves to offset changes in the multiplier. Moreover, both problems will be much less pronounced when the provisions of the 1980 Monetary Control Act are fully phased in. Then, there will be only one class of reservable liability other than checkable deposits, and the reserve requirements on checkable deposits will be the same for all except the very smallest institutions. The other source of uncertainty in the reserves operating procedure concerns the amount of reserves that depository institutions borrow from the Federal Reserve. As mentioned in Section lI the spread between market rates of interest and the discount rate can alter the amount of discount window borrowing, with larger borrowings being associated with higher spreads. Unexpected changes in market rates of interest can alter this spread and cause borrowing to rise or fall unexpectedly, with the result that total reserves, and hence the supply of money, can change. THE DEMAND FOR MONEY
The text describes the first link in the transmission mechanism from the perspective of the credit market, that is, in terms of an increase in bank loans and investments that causes interest rates to fall–at least initially. There is, however, an alternative way to tell this story, which is to look at what happens to the supply of money–the total amount of cash balances held by the public. The increase in bank loans and investments is funded, amo...
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