A Proposal for Reforming Bank Reserve Requirements in the United States

Abstract

In recent years the Federal Reserve has repeatedly replied to those who criticize fluctuations in money growth by claiming that it is impossible to control money growth in the short run.l Yet the Fed has done nothing to improve its control mechanism. The purpose of this paper is to describe a proposal that would provide virtually complete money stock control on a weekly average basis. The costs of accurate control may not be worth the benefits, but the proposal presented below makes clear that the costs and benefits should be analyzed directly rather than the issue ducked by claims that accurate monetary control is technically impossible. Textbook writers have traditionally analyzed the steady-state properties of fractional reserve requirements and the eventual impacts of such disturbances as openmarket operations, currency drains, and changes in excess reserves. It has been recognized for years that fractional requirements promote instability whereas 100 percent requirements would provide essentially perfect control over the money stock. However, the 100 percent system has been assumed to be politically infeasible, and it may be economically infeasible as well. In the absence of payment of interest on reserves, there is a powerful incentive to fractional reserve banking; and regardless of the legal forms and regulatory constraints, banks or banklike firms would likely be successful in inventing depositlike liabilities that would effectively destroy a 100 percent required reserves system. Even the payment of a competitive

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