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Reserve Requirement

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The reserve requirement is the fraction of deposits that a central bank requires that banks hold rather than lend out. Thus, a reserve requirement is a tool of monetary policy. The reserve requirement has such a powerful effect on the money supply that it is considered too blunt to change regularly. In the US, the Federal Reserve usually sets a reserve requirement of approximately 10%, and even slight changes are made very infrequently. US banks must deposit at least their reserve requirement with one of the Federal Reserve branches. At this reserve requirement rate, the US banking system has a simple deposit multiplier of 10. Thus, with a 10% reserve requirement, the Fed can increase or decrease the broad money supply by a convenient 10 times the amount of any open market operation.

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