Contemporaneous Versus Lagged Reserve Accounting: Comment

Increased short-run fluctuations in the growth of money have encouraged numerous investigations of the money creation mechanism. Many of these studies suggest that such fluctuations can be eliminated if the proper reserve measure is used as the operating target of monetary policy. Free reserves have been suggested as the appropriate operating variable by Modigliani, Rasche, and Cooper [7]; the monetary base by Burger, Kalish, and Babb [2]; and reserves against private deposits by Morris [8] . Rather than discuss the merits of each reserve measure, the purpose of this note is to analyze theoretically the dynamics of the lagged required reserve accounting procedure under which the measures must operate (also see [3, 9, 10, 11] ). First, a comparison is made between contemporaneous and lagged required reserve accounting; and, second, the policy implications of their differences are discussed. Consider a simple model of banking behavior which excludes the existence of non-member banks in the banking system, the role of vault cash in reserve management, differences between time and demand deposits, the currency component of the money supply, and alternatives to reserve-bank borrowing such as Eurodollars and commercial paper, to analyze the two methods of accounting required reserves. Also, suppose that banks maximize profits by adjusting their reserve positions so that the demand for nonborrowed reserves, which is defined as the sum of the demand for required reserves RR and the demand for net free reserves FRd, equals the supply of nonborrowed reserves NRo. The banking system's equilibrium condition