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Chapter 28: Q.8 (page 688)

Why might banks want to hold excess reserves in time of recession?

Short Answer

Expert verified

In this given situation, indeed the 'Fed' cannot force individual banks to grant loans.

Step by step solution

01

Concept Introduction

Recession is principally a significant decline recorded in the profitable conditioning, which continues for further than a couple of months. It's recorded in terms of employment, artificial product, real income and noncommercial-retail trade. Any phase which records negative profitable growth for two successive diggings as per a country's gross domestic product (GDP) is considered to be a recession.

02

Explanation

At the time of recession or any economic uncertainty, banks fear that the borrowers might not be able to repay their debts. To combat such difficulties, they keep excess reserves to meet their obligations. This excess reserve is more than what they are legally suppose to hold. As no rule prohibits them from holding additional excess reserves above the legally mandated limit, they choose to hold funds in excess.

Considering contractions in the economy, banks prefer to keep excess reserves above the legal mandate level. In this given situation, even the 'Fed' cannot force individual banks to grant loans.

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Most popular questions from this chapter

How is a central bank different from a typical commercial bank?

Why does contractionary monetary policy cause interest rates to rise?

List the three traditional tools that a central bank has for controlling the money supply.

If GDP now falls back to 1,500 and the money supply falls to 350, what is velocity?

What would be the effect of increasing the banks' reserve requirements on the money supply?
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