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Changes in the demand for reserves can have the same

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Unformatted text preview: ir “announcement” effects, that is, as a way of signaling or announcing to markets a significant change in monetary policy. A higher discount rate can be used to indicate a more restrictive policy, while a lower rate may signal a more expansionary policy. For example, in the dollar–rescue operation of November 1978 and in the anti–inflation measures of October 1979, both of which required a more restrictive monetary policy, the Federal Reserve signaled its intentions by raising the discount rate by then–unprecedented increases of 1 percentage point. CHANGES IN RESERVE REQUIREMENTS In principle, the Federal Reserve has a third monetary policy tool at its disposal: it has the power to change, within statutory limits, the reserve–requirement ratio. This ratio specifies the amount of reserves that depository institutions must have for each dollar of deposits. Changes in the ratio alter the dollar amount of reserves that depository institutions must hold against their deposits; in other words, they affect their demand for reserves. Changes in the demand for reserves can have the same effects as reducing the supply of reserves. A reduction in reserve requirements, for example, would mean that institutions would find that their existing reserves holdings are in excess of what they are required to hold under new, lower requirements. Reducing reserve requirement therefore is equivalent to increasing the supply of reserves: it starts the process of multiple expansion of loans and deposits described earlier, and the process continues until the excess reserves have disappeared. By the same token, an increase in reserve requirements is equivalent to a reduction in reserve supply, causing a multiple contraction in deposits outstanding. Dynasty School (www.dynastySchool.com) 2-21 REAL ESTATE FINANCE In current practice, changes in reserve requirements are seldom used to control money. They are considered too “blunt” an instrument in the sense that relatively small changes in requirements can produce large increases or decreases in money. Moreover, changes in reserve requirements can affect the profitability of deposito...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.

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