reserve requirement

The minimum percentage of their customers' total demand deposits (checking account balances) that banks are legally required to keep on hand in cash or as deposits in their accounts at the regional Federal Reserve bank. In the United States, the Federal Reserve's Board of Governors is empowered to set the reserve requirement for member banks at its discretion. This power provides one of the Fed's more powerful policy tools for influencing the banks' willingness and ability to extend or call in loans, and thus to influence the size of the money stock and the level of prevailing interest rates. Lowering the reserve requirement is expansionary. Lowering the reserve requirement increases the bankers' availability of funds to make more loans, thus tending to expand the money stock and (in the short run at least) to lower interest rates and encourage both consumers and investors to buy more. Raising the reserve requirement represents a contractionary move by the Fed. Raising the reserve requirement restricts the bankers' ability to make more loans, and those banks that were already operating just barely above the old reserve requirement will probably be forced to call in some of their existing loans to meet the tougher new requirement, thus tending to shrink the money stock, raise interest rates, and thus reduce the volume of purchasing on credit in the economy as a whole.

[See also: Federal Reserve System, monetary policy, money stock, banking, money]