Do Central Banks Need Minimum Reserves?

In this paper I tried to show that the economic arguments in support of reserve requirements are not strong. Reserve requirements were long regarded as an essential instrument for the control of the money supply and the ultimate target variables of monetary policy. However, a substantial body of research suggests that the importance of reserve requirements for monetary control has been overstated. Central banks operating in highly developed and globalized financial markets are well advised to employ market-related techniques of monetary policy, rather than to rely on quantitative restrictions such as reserve requirements. If reserve ratios are high, such requirements may even turn out to be counterproductive in that they distort deposit and credit flows. This is likely to undermine the indicator role of monetary aggregates and to complicate the tasks of central banks. Nevertheless, modest reserve requirements may assist central banks in the operational aspects of monetary policy. Ample reserves allow commercial banks to play a shock-absorber role in the money market. Commercial-bank buffer stocks reduce the need for central banks to moderate interest-rate volatility by "fine-tuning" their money-market operations and/or by acting as lenders of first resort to commercial banks.