The Concept of Excess Reserves - Assignment Example

Macro and Micro Economics Impacts of Excess Reserves Cash funds held by banks above and over the Federal Reserve requirements grow intensely over a financial crisis as excess reserves. The excess reserves held in the banks are now attractive to most banks since the cost of having excess reserves is low. However, excess reserves that banks hold in response to risks and interest rates suggest that reserves are not likely to cause massive and unexpected increases in the bank loan portfolio. In contrast, banks' preparation to handle any changes is not clear in future, in case the perceived conditions change (Craig and Koepke 1).

From the time of the financial crisis, American Banks increased their excess reserves in terms of cash funds held over and above the Federal Reserve requirement. Besides, the Excess reserve increased from $1.9 billion in the year 2008 the month of August to $2.6 trillion in January 2015. Additionally, U.S banks are holding liquidity by pumping it into the economy through the Federal Reserve as excess reserves. Besides, instead of giving loans, implications lie in monetary policy and the real economy, which is elusive in the current economic environment since it is new and complex.

Before excess reserve crisis Before the crisis in October 2008, the costs and benefits of holding reserves became clear. The costs entailed the benefits of guarding last-minute outflows and foregone interest that requires immediate cash. Furthermore, depositors set aside money to cover emergency expenses, or investors hold reserves to enable them to seize unforeseen opportunities (Craig and Koepke 1). Implications Craig and Koepke suggest that the Simplicity of one-to-one correspondence between excess reserves and the Federal Reserve balance sheet hides difficulty in predicting how banks behave in the presence of expanded reserves (1).

Unfortunately, understanding this behaviour is imperative in deciding an appropriate policy that guards excess reserves development.