On the Optimality of Reserve Requirements

Abstract

An implicit rationale for a bank reserve requirement is that a central monetary authority is in a unique position (as "social planner) to impose a "socially superior" outcome to that yielded by a free banking system. We illustrate how this can be true in the context of a simple economy modeled to mimic certain basic characteristics of a monetary economy with banks and agents who trade with one another. Banks exist in our model because by pooling liquidation risks they provide liquidity otherwise unavailable to depositors, which, in turn, provides the incentivefor using deposit claims as the medium of exchange.

Are There Optimal Multiple-Reserve Requirements?

“…Thus, this paper extends the literature on optimal single reserve requirementsa literature that includes contributions by Freeman {1987), Brock (1989), Bencivenga and Smith (1992), Mourmouras and Russell (1992), Cothren and Waud (1994), and E:spinosa and Yip (1996) -to the case of multiple reserve requirements.…”

“…And since the allocation supported by the lower reserve ratio involves a lower implicit tax rate, it should Pareto dominate the allocation supported by the higher reserve ratio. 4 The possibility of Pareto-inferior single-currency-reserve equilibria with relatively high reserve ratios suggests that imposing conventional multiple reserve requirements may produce efficiency improvements only if the initial single-reserve equilibria are "bad" high-rese~ ratio equilibria, and that conventional multiple-reserves regimes cannot in fact improve on the corresponding "good" low-reserve-ratio equilibria. We show in our Proposition 1 that this is precisely the case -that a conventional multiple-reserves equilibrium can Paretodominate a single-currency-reserve equilibriwn only if the latter equilibriwn is also Paretodominated by a single-currency-reserve equilibriwn with a different reserve ratio.…”

Reserve Requirements, Bank Runs, and Optimal Policies in Small Open Economies

“…The literature on the optimality of maintaining a stock of liquid reserves is broad (Baltensperger (1974), Santomero (1984), Cothren and Waud (1994), Stein (1995), Agénor et al (2000)). Also, there are some works that analyze the use of reserve requirements from a macroeconomic standpoint: as a countercyclical tool (Edwards and Végh (1997), Calvo et al (1993)), as a mechanism to enforce capital requirements (Fernandez and Guidotti (1996)), or as an instrument that helps to collect the inflation tax (Englud and Svensson (1988)).…”

“…Technically, this assumption will allow the study of interest rate shocks in the SOE set up, providing a mechanism for adjusting to a new steady state. 6 Also, this is a realistic assumption for most emerging markets, which tend to pay a risk premium on their debt. With perfect capital mobility, countries would be able to completely finance a bank run abroad, and nothing would happen domestically.…”

“…They are important for example in economies with fixed exchange rates, currency board arrangements, or even flexible exchange rates where the stock of deposits is highly dollarized. 6 For other mechanism to close the SOE model under interest rate shocks see Schmitt-Grohe, S. and M. Uribe (2001). The purpose of those mechanisms is to generate some transitional dynamics that put the SOE in a steady state, otherwise it will diverge forever.…”