By Alex Wyckoff
Source: Council on Foreign Relations
On March 26th, the Federal Reserve shifted United States reserve requirements for banks to 0% in response to the COVID-19 crisis and its impact on both the United States and the global economy.
The reserve requirement is a rule set by the Federal Reserve requiring all member banks to maintain a certain amount of funds on hand. Before the rule change, banks with more than $16.9 million on deposit were required to keep at least 3% of all deposits on reserve, and banks with more than $127.5 million on deposit were required to keep at least 10% of all deposits on reserve. Banks smaller than $16.9 million were exempted from the rule. As of March 26th, the requirement for all banks is now 0%.
“The Fed is dusting off the financial crisis playbook,” Bankrate.com’s chief financial analyst Greg McBride said in an interview with Forbes. “Returning to bond buying, coordinating with other global central banks to provide access to U.S. dollar liquidity, cutting interest rates to zero and opening the Fed’s discount window to ensure the flow of credit through banks to consumers and businesses.”
The reserve requirement has existed in the United States in a variety of forms since the 1820's, though the modern system originated with the Federal Reserve Act of 1913, which established the Federal Reserve in an effort to create a lender of last resort for banks that fell short of cash deposits needed for customer withdrawals.
In the late 1930's during the aftermath of the Great Depression, the Federal Reserve decided to pursue a more proactive role, using newfound powers granted by the Banking Act of 1935 to prevent overly rapid expansion of credit.
“The Federal Reserve has a responsibility to ensure the safety and soundness of financial institutions and to contain systemic risks in financial markets,” Senator Bernie Sanders once said of the institution. “The Federal Reserve has the responsibility to protect the credit rights of consumers.”
Today the reserve requirement acts as one of the chief policy agents for controlling liquidity in the United States monetary system, acting as a limit for how much of their deposits banks are able to loan out to businesses and other financial institutions to stimulate economic growth.
The Fed changes reserve requirements in response to or in anticipation of market fluctuations, controlling how much money is being lent out by banks and thus how much money is in the economy at one time so as to control inflation and contain the expansion of bank credit. The elimination of the reserve requirement is the most extreme change to the policy since its inception.
The changes will remain in place until the Fed is, “confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals,” as said in a statement by the Federal Open Market Committee.
In addition to the elimination of the reserve requirement, the Fed has also slashed interest rates to near zero and joined the Bank of Canada, Bank of England, Bank of Japan, Swiss National Bank, and European Central Bank in lowering the prices on US liquidity swap arrangements. The Fed has also adopted a quantitative easing strategy similar to what was employed during the Great Recession, promising to purchase $500 billion in Treasury securities and $200 billion in mortgage-backed securities.
The changes, however, are not enough to offset the rapid economic deceleration that has been initiated by the crisis, with stocks plummeting thousands of points and nearly wiping out gains from the last three years in a matter of weeks, and some states reporting unemployment filings at rates that exceed the height of the Great Recession.
“We do recognize that a rate cut will not reduce the rate of infection; it won’t fix a broken supply chain,” Fed Chairman Jerome Powell said at a press conference in mid March. “We will maintain the rate at this level until we’re confident that the economy has weathered recent events and is on track to achieve our maximum employment and price stability goals.”
Alex Wyckoff is a community organizer and former employee of the California Democratic Party. He is currently a first year graduate student studying public policy at UC San Diego with a focus in security policy and social inequality.