Question

After the 2008 recession, the amount of reserves in the US banking system increased. Because of Federal Reserve actions, required reserves increased from $44 billion to $60 billion. However, banks started holding more reserves than required. By January 2009, banks were holding $900 billion in excess reserves. The Federal Reserve started paying interest on the excess reserves that the banks held. What possible impact will these unused reserves have on the economy?

Answer 1

Answer:

The economy will face inflation

Explanation:

Inflation is an economic term referring to a general increase in prices. It is caused by a rise in aggregate demand or by a surge in the cost of inputs.  An excess in the supply of money in the economy causes the aggregate demand to rise at a higher rate than the supply. Firms respond by increasing prices to counter the high demand leading to inflation.

The Fed opted to pay interest on excess reserves to make it attractive for banks to hold reserves. Paying interest on excess reverses gave the fed more control over the federal fund rate and, by extension, money supply. The excess reserves would have increased aggregate demand causing inflation in the economy.

Answer 2

Answer:

The economy will face inflation

Explanation:

Inflation is an economic term referring to a general increase in prices. It is caused by a rise in aggregate demand or by a surge in the cost of inputs.  An excess in the supply of money in the economy causes the aggregate demand to rise at a higher rate than the supply. Firms respond by increasing prices to counter the high demand leading to inflation.