The Freeman 1972 - The Ludwig von Mises Institute

1972 THE FEDERAL RESERVE SYSTEM 249Reserve System is its authority tochange the reserve requirementsof its member banks. Both therediscount process· and the openmarkettransactions either increaseor decrease member bankreserves, and hence.the amount ofcredit which these banks can· makeavailable. But changing the percentageof its deposits which abank must keep as a reserve is aneven more drastic form of influenceover the money and· creditsupply.Suppose a, bank has one milliondollars of demand deposits. If thereserve requirement is ten percent, it must .keep one'hundredthousand dollars in its ReserveBank. It may loan out or investthe rest. But if the reserve requirementshould now be lowered,let us say, to five per cent, ourbank would need only fifty thousanddollars as a reserve againstits demand deposits. It can nowlend or invest the remaining$50,000.If' this were the only effect,only $50,000 of additional moneywould enter the economy. In reality,however, this is merely thebeginning of a chain of moneycreation.. Let's assume that ourbank·decides to hold the reservesthus set free as "excess reserves."It may then extend more credit toits customers. Of course, it wouldhave to proceed very slowly lest itlose its reserves to other banks orcustomers demanding cash. It cannot.proceedany faster than otherbanks that also are expandingtheir credits on the basis of theirnewlywonexGess reserves.This is an oversimplification, 'ofcourse. But the impact on thecapital and money markets ofchanges in reserve requirementsis extremely potent. It is estimatedthat at present a, fluctuationof only one per cent tends to increaseor decrease the total volumeof bank credit by more than sixbillion dollars. This authority tovary reserve requirements wasgiven to the Federal Reserve Systemin 1933, as a special em,er~gency power. Since 1935 it hasbeen a permanent instrument ofcredit control.A Most Important Toolin the Armoryof InterventionAn appraisal of the good pointsand bad points of the Federal ReserveSystem depends on the politicaland economic philosophy ofthe appraiser. If he fa,vors' governmentcontrol over our economyhe will regard the Federal Reservemost favorably, for it holds absolutepower over the people's moneyand credit.If· one is convinced of the beneficialnature of an enterpriseeconomy, he will unconditionally