Reply To: Excess Reserves


The Fed’s balance sheet shows total assets of $3,601 billion. Securities held are $3,380 billion. So 94 percent of Fed assets are securities that it has purchased, not loans. Loans are $227 million (yes, million with an “m”) or 0.008 percent of Fed assets. And $154 million of that $277 million are “seasonal loans” which have nothing to do with the crisis.

The Fed did not loan money to banks. It bought securities from banks. The Fed paid banks by crediting checking account balances that banks hold at the Fed. This is the normal manner in which the Fed generates monetary inflation. The Fed buys securities from banks and pays with newly created money substitutes, the banks then use the money substitutes as reserves and issues their own money substitutes (i.e., customer checking accounts) by making loans to customers.

Reserves of banks are funds they hold against their checking account balances. The Fed requires banks to hold these funds as either cash or checking account balances at the Fed. The Fed sets the reserve requirement ratio that banks must meet, which is roughly 10 percent of their checking account balances. Banks cannot hold less than required reserves, but they can hold more. Any reserves banks hold in excess of those required by the Fed are “excess reserves.”

For example, customers of Bank A have a total of $10,000,000 in their checking accounts. If the reserve requirement ratio for Bank A is 10 percent, then Bank A must hold a minimum of $1,000,000 as reserves. It can hold these reserves as either cash or in a checking account balance with the Fed. If Bank A actually holds $1,200,000, then it is holding $200,000 in excess reserves. The excess reserves, like any reserves, can be either cash or checking account balances at the Fed.

The money stock is not 90 percent above people’s spending levels. The additional checking account balances come into existence as loans to customers. The customers are borrowing to spend the money. the recipients of the money then apportion it between money holding, consumption spending, and investment spending. As the new money is spent on more and more goods, their prices rise. If any person believes that his money holdings are too large, then he spends it to buy goods or invests it (and the borrower spends it on goods) and the money continues to bid up prices further. At higher prices, i.e., lower purchasing power of the monetary unit, people need to hold more money to command the same purchasing power over goods. This is the process by which prices are bid up from the monetary inflation generated by the Fed. At the end of the process people desire to hold all the money that exists.

Yes, saving account balances can be money substitutes if banks have a practice of redeeming them on demand at par for money. The Fed sets a lower reserve requirement for them than it does for demand deposits.

The main assets of commercial banks are loans and securities.

As the link below reveals, banks don’t have a significant portfolio of land and corporations.