Excess reserves

The banking system has been — and continues to be — at the heart of many of the current economic issues. One of the terms that comes up these days in discussions of today’s economy and banks is excess reserves. N.C. State University economist Mike Walden explains what it means and why it’s important.

“Well, first of all let me define reserves. People put money in a bank. Banks then take some of that money and lend it out and make investments. However, law requires — and I think just common sense requires — that banks keep some of those deposits back in the vault. Those are called reserves, and what that does is it allows the banks to meet unexpected demands … (when) a lot of people want to go in and withdraw their money. Yeah, there’s money back in the vault rather than being loaned out.

“If a bank keeps money in a vault that’s above what they legally need to keep in terms of reserves — that is, they’re keeping more than they really need to back in the vault — that’s called excess reserves.

“And excess reserves right now … are at a record, record high. Banks have simply not been lending out that money. They have simply been putting it back in the vault.

“The Federal Reserve actually pays the banks a little bit of interest on those excess reserves that they have back in the vault. And one impact of this … is that …, I’m sure, you’ve heard and we’ve talked about the Federal Reserve creating money — which they do have the power — and in essence shipping that money to banks. And people worry about all that money creation may spark higher inflation.

“One reason why it hasn’t is because those extra monies have not been deployed in terms of investments. They’ve been held back in the vaults of banks.

“So, again, I think this is an indication of the challenge in our economy. The fact that banks are hoarding more money back in the vault, I think, suggests that they still view the economy as somewhat weak and they don’t see as many investment opportunities out there as we normally see.”

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