The Federal Reserve’s Influence Over Excess Reserves

As the economy continues to emerge from the recession, it is not yet clear how sustainable the recovery is. One concern is the strength of bank lending and banks’ apparent preference to hold reserves instead of lending to consumers and businesses. Banks are required to hold a percentage of their customers’ transaction accounts as reserves at the Federal Reserve, but reserve balances greater than those required are considered to be excess reserves. The level of excess reserves has expanded more than twentyfold since September 2008, leaving many to question why have banks have decided to hold such high levels of excess reserves instead of lending them out. In actuality, banks have little control over the aggregate level of excess reserves—changes in excess reserves are driven by changes in the Federal Reserve’s balance sheet.