Would uniform reserve requirements for all deposit institutions significantly increase the effectiveness of the Federal Reserve policy and end adverse discrimination against commercial bank deposits? This article says it's not likely and shows why.
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References
1.
Although this would appear to be a convenient way to extend the control of the Federal Reserve, any such plan would have to overcome serious legal and political obstacles before it could be extended to all deposit institutions. Any plan to authorize the central bank to impose reserve requirements on all deposit institutions would not be just another piece of technical monetary gadgetry: It would be a direct challenge to the dual banking system and to states' rights. In this connection, it is significant that compulsory membership in the Federal Reserve has never been required for all commercial banks. The Congress has not even sought to extend Federal Reserve control over all banks by the indirect method of requiring membership in the Federal Reserve as a condition for membership in the FDIC. Would Congress now be willing to exercise compulsion towards the deposit institutions which it has not exercised towards commercial banks? As an alternative, if Federal Reserve control were to be extended by provisions for voluntary membership by all deposit institutions, the effectiveness of extending the controls to nonbanks would be sharply limited. With voluntary membership, the exercise of the controls would be inhibited by the fear of driving the member institutions out of the system.
2.
Unlike reserves that are presently held by nonbank institutions, the current reserve proposals are designed primarily for credit control purposes.
3.
For a different view, cf. HendersonJ. M., “Monetary Reserves and Credit Control,”American Economic Review, June, 1960, pp. 348–369.
4.
For example, a uniform reserve plan has implications for competition among the deposit institutions, possible portfolio effects, and earning effects. It is possible, too, that a uniform reserve plan would lead to demands for full bank status by the nonbank deposit institutions.
5.
For example, cf. SmithW. L., “Financial Intermediaries and Monetary Controls,”Quarterly Journal of Economics, November, 1959, pp. 545 and 552.
6.
This discussion is limited to a system in which legal reserves would be held in the form of deposit balances rather than in some other form, such as securities.
7.
For simplicity, the existence of currency is ignored in this paper.
8.
For an analysis of the effects of holding the reserves of the nonbank deposit institutions in the form of commercial bank deposits, cf. AlhadeffDavid A., “Credit Controls and Financial Intermediaries,”American Economic Review, September, 1960, especially pp. 658–661.
9.
The distinction between “active” and “idle” is like the familiar distinction between M1 and M2.
10.
Cf. SmithW. L., “On the Effectiveness of Monetary Policy,”American Economic Review, September, 1956, p. 601.
11.
Cf. Federal Reserve Bulletin. The figures are year-end figures.
12.
But the unstabilizing interval might be a lengthy one.
13.
Although it would be unusual to transfer active demand deposits to SLA, it is worth noting that such transfers would also be economically unstabilizing. Moreover, the unstabilizing consequences would be opposite from those which result from a transfer of idle demand deposits. Under URR, the expansion of credit by SLA could exactly match the contraction of commercial bank credit, leaving the combined total credit volume for both institutions unchanged. However, the transfer would be deflationary because the decline in spending which is implied by the transfer of an active demand deposit could only partly be compensated by the expansion of SLA credit. Part of the funds deposited in the SLA would have to be permanently impounded in the form of legal reserves and would not be available for spending by the public. The reader will note that this deflationary result is obtained in spite of the continued assumption that the banking system would adjust its reserves without forcing a further reduction in spending by its depositors. In fact, even under these circumstances, a transfer of active demand deposits to SLA would be more unstabilizing under URR than at present. At present, the net effect of this transfer would be only slightly deflationary because the effective reserves of the SLA are small and the net reduction of the active money supply would be limited to the comparatively small amount impounded in SLA reserves. Under URR, however, the SLA's legal reserves would presumably be greater than their present effective reserves. Hence, following the expansion of SLA credit, a smaller amount would be restored to the active money supply under URR than at present.
14.
The figures which follow are from the Federal Reserve Bulletin, June, 1961.
15.
This discussion of technical adjustments should not obscure the fact that a proposal to free bank reserves to cover the newly controlled institutions would involve a transfer of earning assets from the latter to the former. In turn, the earning power effect might be reflected in changed competitive relations among the different deposit institutions. Although these are important practical considerations, they can be ignored for the purposes of this paper.
16.
This calculation is based on reserves deposited with Federal Reserve Banks and ignores both vault cash and balances with domestic banks. The distinction between commercial bank demand and time deposits is also ignored because both would be subject to uniform reserves under URR.
17.
For simplicity, assume that MSB and SLA earning assets are sold to member banks only. If the earning assets were sold to the public instead, the member banks would initially lose deposits and reserves but could restore their deposits by additional extensions of credit.
18.
This is a reasonable figure because the Federal Reserve would probably not require large increases in the reserve ratio. Under URR as at present, large increases would be chaotic for the banks.
19.
As SmithW. L. has pointed out: “Even during moderate declines in business activity, such institutions can ordinarily find sufficient outlets in the private sector for most of the funds they take in, and they usually exploit these outlets in a steady predictable fashion by letting out such funds as they receive on a current basis at whatever the prevailing yields may be. Rarely do they invest much in short-term government securities or other highly liquid assets while awaiting more favorable conditions for committing funds at long term.” SmithW. L., “Financial Intermediaries and Monetary Controls,”Quarterly Journal of Economics, November, 1959, pp. 550–551. Cf. also Economic Study of Savings Banking in New York State, prepared for the Special Committee of the Savings Bank Association of the State of New York to Cooperate with the Joint Legislative Committee to Revise the Banking Law (1956), pp. 142–144.
20.
BogenJules I., “Trends in the Institutionalization of Savings and in Thrift Institution Policies,”Proceedings of the Conference on Savings and Residential Financing, sponsored by the United States Savings and Loan League, May, 1960, p. 108.
21.
U. S. Savings and Loan League, Quarterly Letter on Home Mortgage Lending, March, 1960, p. 3.
22.
The indirect impact is discussed later.
23.
Although the repurchase of securities might not exactly reverse the effects of selling the securities, there is no a priori reason to expect the net impact on bank and nonbank deposits—if share accounts and open market securities were highly substitutable—to be systematically biased as a result of the cycle of sale and repurchase of securities.
