Reserve Requirement as a Tool of Monetary Policies

A banker would like his money holdings to be reduced to a minimum, since they produce no income.

But there is always an important reason for the banker to hold his money balances at a certain level. The Central Bank makes him hold a certain share of his total balances in reserve. These reserve balances must be in the form of cash or of deposits made by commercial banks with a certain authorized bank. Most of reserve balances are known to be in the form of deposits. Setting the reserve requirements, the Central Bank can regulate money circulation and money supply in an economy.

The Central Bank can, on the one hand, increase commercial banks' re­serves by direct intervention. One way of doing this is by the so-called open market operations: it buys government bonds from the public; thus, the money that goes to the public in payment for these bonds will eventually be depos­ed with commercial banks, most likely in interest-earning deposits. Having been deposited with a bank, money stops being money, but it represents a net addition to reserve balances capable of supporting (зд. гарантировать) loan transactions several times their own value. For this reason, the Central Bank is said to have supplied "high powered" money to commercial banks.

On the other hand, selling bonds to the public, the Bank can reduce the banking system's reserves and thus make the money supply reduce.

Open market operations are not the only method of direct reserve inter­vention. Another way for the Central Bank to increase money in circulation is to make loans to commercial banks who in turn lend out to the public the money to be used for daily expenditure.

Finally, the Central Bank can change the money supply without affecting the amount of reserves to be held by commercial banks. It can do this simply having changed the reserve requirement. Having been decreased from 20 per­cent to 10 percent, the reserve balances will actually double their capacity to support transactions. As a result, maintaining the same reserve balances, banks get a chance of handling loan transactions twice as large as before.

Thus, the three monetary policies a Central Bank can implement are as follows: 1. Open market operations. 2. Loans to commercial banks. 3. Changes in reserve requirements.

Unit 15: inflation

Text 1: Read and translate the text

Iflation

Inflation is a steady rise in the average price and wage level. The rise in wages being high enough to raise costs of production, prices grow further re­sulting in a higher rate of inflation and, finally, in an inflationary spiral. Peri­ods when inflation rates are very large are referred to as hyperinflation.

The causes of inflation are rather complicated, and there is a number of theories explaining them. Monetarists, such as Milton Friedman, say that inflation is caused by too rapid increase in money supply and the correspond­ing excess demand for goods.

Therefore, monetarists consider due government control of money supply to be able to restrict inflation rates. They also believe the high rate of unem­ployment to be likely to restrain claims for higher wages. People having jobs accept the wages they are being paid, the inflationary spiral being kept under control. This situation also accounts for rather slow increase in aggregate demand.

On the other hand, Keynesians, that is, economists following the theory of John M. Keynes, suppose inflation to be due to processes occurring in money circulation. They say that low inflation and unemployment rates can be ensured by adopting a tight incomes policy.

Incomes policies, though, monetarists argue, may temporarily speed up the transition to a lower inflation rate but they are unlikely to succeed in the long run.

The costs of inflation depend on whether it was anticipated and on the extent to which the economy's institutions allow complete inflation adjustment.

The longer inflation continues, the more the economy learns to live with it. Indexation is a means to reduce the costs of some inflation effects. In­dexed wages or loans mean that the amount to be paid or repaid will rise with the price level. Indexation has already been introduced in countries that had to live with inflation rates of 30 or 40 percent for years. And the more coun­tries adjust their economies to cope with inflation, the closer they come to hyperinflation. Indexation means that high rates of inflation are much more likely to continue and even to increase.