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Unformatted text preview: een uniform across institutions. Prior to passage of the Depository Institutions Deregulation and Monetary Control Act in 1980, only banks that belonged to the Federal Reserve System, called member banks, were subject to reserve requirements set by the System. Non–member banks, which accounted for approximately 30% of total demand deposits, were subject to the reserve requirement set by the states in which they were located. These state–mandated reserve requirements were on average lower than the Fed's requirements. More importantly, in many states, banks could include as reserves such assets as government securities over which the Federal Reserve had no control. Finally, thrift institutions were not subject to reserve requirements at all. Because the Fed paid no interest on reserves, these differences gave rise to a highly inequitable situation in which the costs of reserve requirements were significantly higher for member banks than for nonmembers and thrift institutions. The result was a progressive deterioration in the Federal Reserve's control over the money supply as more and more banks rejected System membership. The Congress dealt with this problem in the Monetary Control Act of 1980. When the provisions of this Act are fully phased in, the checkable deposits of all depository institutions will be subject to uniform reserve requirements set by the Federal Reserve. As a result, the System's control of the money supply will be significantly enhanced and inequities reduced. The system of fractional reserve banking (in what follows we shall often refer to all depository institutions as banks) means that total deposits issued by banks are a multiple of the amount of reserves they have on hand or on deposit with Federal Reserve Banks. For example, if the average required reserve ratio were 12% (the rate that ultimately will be effective on most transactions accounts under the 1980 Monetary Control Act), banks would be able to issue $8.33 of deposits for every dollar of reserves they have. When the amount of reserves in the banking system changes, a chain reaction is set off that eventually causes the to...
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- Spring '10