Understanding Movements in
Bank Reserves
Introduction
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The balance sheet of the Fed shows the
movements of reserves in the system
Very complicated since many things can
impact the level of reserves
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Open Market operations and Discounting
Other entries may offset movements in reserves
The Fed does not control many of these items
US Treasury can add or absorb bank reserves
through fiscal spending or tax revenue
Bank Reserve Equation
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The expanded view of reserve
movements
A summary sheet for sources and uses
of reserves
Useful for monitoring trends in
reserves—fundamental framework of
monetary control.
The Fed’s Balance Sheet
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Every item on the balance sheet (asset or
liability) has an effect on reserves
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Total assets = total liabilities
Fed’s total liabilities include reserves—“bank
deposits” in the Fed plus cash in bank vaults
Therefore, bank reserves must equal total Federal
Reserve assets minus all other Fed liabilities
Anything affecting a Fed’s asset or liability must
alter reserves, unless it is offset somewhere
else in the balance sheet
Federal Reserve Float
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Arises in process of clearing checks
“Cash items in process of collection” (an
asset) minus “deferred availability cash
items” (liability).
The difference between the two is the “float”
The Fed credits the deposit (reserve) account
of the bank sending a check for collection to
the Fed before it debits the deposit (reserve)
account of the bank on which the check is
drawn.
Fed Float
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Float can fluctuate considerably, either
adding to or subtracting from reserves
Can cause serious short-term
disruptions in bank reserves.
An increase (decrease) in float raises
(lowers) bank reserves and the
monetary base dollar-for-dollar.
Check 21
Federal Reserve Notes
Outstanding
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Liability to the Fed, but an asset to holder of
the currency
The change in this account does not alter
bank reserves—notes outstanding rises,
bank deposits at Fed falls
If the public decides to hold more currency,
then bank reserves are lowered.
Tax and Loan Accounts
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Accounts held by the Treasury at
commercial banks.
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The result of its tax collections and bond
sales.
Increases in these accounts does not
increase reserves, but when they are
transferred from the banking system to the
Treasury’s account at the Fed, reserves fall.
U.S. Treasury Deposits
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The “working balance” of the Treasury
reflected in spending and tax revenues
Types of Open Market
Operations
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We have assumed that the Fed could control
the volume of reserves by use of open market
operations
However, the reserve equation demonstrates
that other influences outside control of the
Fed can affect reserves
These outside influences need to be
forecasted and monitored to assist the Fed in
controlling the level of reserves
Defensive Measure
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Fed engages in open market operations aimed at
defending a target level of reserves from “outside”
influences.
 If the FOMC learns that there will be a sudden
heavy conversion of tax-and-loan accounts into
Treasury balances at the Fed, it may order open
market purchases to offset this drain of reserves.
Offset transitory changes in reserves which are trying
to push level of reserves outside the range desired by
the Fed
Extensive use of Repurchase Agreements as
temporary injections or deletions of reserves
Dynamic Measures
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Open market operations aimed at either
increasing or deceasing the overall level
of bank lending capacity by changing
the level of bank reserves
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“Take the initiative” to actively affect
reserves.
Defensive far outnumber dynamic.
Monetary Base
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What specific variable should the Fed attempt
to control to regulate money supply?
Control variable (operating target) is the
immediate objective of open market
operations
It is suggested that the Fed should attempt to
control the monetary base—total reserves
plus currency held by the nonbank public.
Reserve equation can be altered to focus on
the monetary base.
How Does the Treasury Finance
Government Spending?
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Collecting taxes
Borrowing from the non-bank public
Borrowing from the banking system
Borrowing from the Federal Reserve
Printing money
Collecting Taxes
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Taxes are deposited in the Treasury’s
tax and loan accounts at commercial
banks.
The Treasury shifts the funds to a FRB.
The government spends the money
collected.
Borrowing from the Non-bank
Public
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Treasury sells bonds to public
Borrowing from the Banking
System
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Banks fully loaned up
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Have to dispose of other assets to buy the
government securities.
Initially the money supply is decreased, but
as the Treasury spends funds, the public’s
money holdings are restored.
Banks have excess reserves
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When the Treasury spends, individuals
receive brand-new demand deposits.
Borrow from the Federal
Reserve
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Sells bonds to the Federal Reserve.
When the Treasury spends funds, the
public winds up with more demand
deposits and the banks with more
reserves.
Modern version of printing money to
pay the government’s bills.
Printing Money
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The money supply and reserves
increase.