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The Reserve Ratio - The Reserve Ratio The FED controls the...

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74 The Reserve Ratio The FED controls the ratio of legal reserve to demand deposits. This tool aids in maintaining confidence in the “fractional” banking system . Raising Reserve Ratio Lowering Reserve Ratio • Increases the amount of $ required to be withheld from loaning and investment activity. • Decreases the amount of $ required to be withheld from loaning and investment activity. • Diminishes the ability of a bank to make new loans and increase the money supply—lower excess reserves are now available. • Increases the ability of a bank to make new loans and increase the money supply —greater excess reserves are now available • Banks would need to receive new demand deposits or they may be forced to foreclose on loans to be compliant. • Banks can issue more loans if they have customers willing and able; they may have new funds for investments The Discount Rate The FED can make short-term loans to its member banks. It will act as the “lender of last resort”. Raising the Discount Rate Lowering the Discount Rate • CB will be discouraged to borrow at higher rates • CB will be encouraged to borrow at lower rates • CB will not increase their excess reserves • CB may choose to increase their excess reserves • Money creation will be decreased because fewer new loans are given
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