Fed is the US central bank, and it is concerned mainly with managing the circulation of money in the economy (Banks para 1). It supplies the currency to the economy by regulating how the banking systems lend money to the public. Additionally, the Fed receives the deposits from other deposit- taking institutions since it is statutory requirement that the banks maintain a certain deposit with the Fed. This system often known as fractional-reserve system ensures that the banking system has enough cash (liquidity) to meet their financial obligations.
The Fed can raise or lower the banking system’s reserve depending on the desired objective. It can increase the reserve in banks in various ways. One of the ways in which Fed can raise the reserve in the banking institutions is by lowering the reserve fraction or the reserve requirement. The reserve requirement is the fraction of deposit that the banking instructions are required to maintain with the Fed (Mankiw 82). If the Fed lowers this requirement, banks will have more cash in their reserves. Fed can also lower the Fed rates to encourage banks to borrow. This way, the banking system will have increased liquidity since banks can borrow more from Fed.
The impact of increased demand deposits resulting from the sale of real estate
If the money received from the sale of real estate is used to service the mortgages, it means that the banking system has a higher inflow of cash. Additionally, if the shareholders deposit their equities into the banking system, the banks will have more cash if the rate of issuing loans is not the same as the rate of receiving cash. Since the banks already have enough liquidity, the Reserve will increase if there are no borrowers to borrow the increased cash. The amount that the banks remit to the Fed will increase. If the banks are willing to issue loans to the business people but the business people are unwilling to take them, banks will have accumulated funds. As such, they will not borrow from the Fed. Consequently, the Fed will be forced to lower the Fed rates to encourage borrowing.
Works Cited
Banks, Federal Reserve. Central bank. 8 Apr. 2016. Web. 4 Aug. 2016. <https://www.frbservices.org/centralbank/>.
Mankiw, Gregory N. Principles of Microeconomics. 6th ed., United States, Cengage Learning, 7 Feb. 2011.
