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Deposits were in turn held to be an indispensable

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Unformatted text preview: of borrowers, in particular those without direct access to capital markets. Deposits were in turn held to be an indispensable source of funding for the lending of commercial banks, and these these were subject to legal reserve requirements. To the extent that reserve requirements ments were typically a binding constraint, a reduction in the supply of reserves by the Federal Reserve would require the volume of deposits to be reduced, which 1 For example, in the model without credit frictions expounded in Figure 2 below, a banking panic that reduces the money multiplier will have no effect other than to increase the supply of base money required to implement the central bank reaction function represented by the schedule MP. 24 Journal of Economic Perspectives would would in turn require less lending by commercial banks. Bernanke and Blinder (1988) and Kashyap and Stein (1994) offer expositions of this view; Smant (2002) provides provides a critical review of the literature. Clearly, Clearly, the importance of this channel for effects of monetary policy on economic activity depended on the validity of each of the links in the proposed mechanism: that reserve requirements were a binding constraint for many banks; that commercial banks lacked sources of funding other than deposits; that an important subset of borrowers lacked sources of credit other than commercial banks; and that banks lacked opportunities to...
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