Question:
Is it bad that the Fed discontinued the reserve ratio? Is this only temporary? Does this mean banks can create and lend out infinite amounts of money? I'm learning about this in macroeconomics (and the textbook is outdated of course) and I was surprised to find out that the reserve ratio is 0 now.Answer:
The RR is one instrument the Fed uses to control money supply or the amount of money in circulation. The Fed deems that the other instruments, such as open market operations, are better. One reason the Fed discontinued reliance on the RR is that banks in the past were forced to hold barren reserves and banks complained the Fed was not paying them interest on those reserves. No one knows if this is a temporary or permanent move. If the economy heats up, the Fed may impose RR again. And no, banks cannot create and lend infinite amounts of money. Banks lend what they receive as deposits and they can successfully attract deposits only when they can offer a decent return; the latter is difficult to achieve if the banks lend indiscriminately. As for whether getting rid of the RR was a bad move or not: I doubt many economists feel it was a bad move. One extra function of holding reserves was self protection on the part of banks against bank runs. With the success of the FDIC, that concern is not as strong as it used to be.
