Asset-based Reserve Requirements: Some Reservations

Thomas Palley's (2004) paper 'Asset-based reserve requirements: reasserting domestic monetary control in an era of financial innovation and instability' has radical implications for monetary policy and the operations of central banks in the money markets. This comment argues that Palley's proposal may be impractical today because it overlooks banks' holding of excessive reserves (or claims on such reserves), and because reserves allocated for particular kinds of business cannot be isolated in bank balance sheets or markets. In particular, once differential reserves are imposed on particular kinds of business, banks may respond to changes in reserve requirements by varying their assets in less predictable ways than the scheme suggests. A central bank's willingness to use differential reserve requirements will be inhibited by the current policy doctrine that emphasises control of a stable money market rate of interest. In any case, it is doubtful if interest rates or reserve requirements could have the specific targeted effects that Palley's model suggests.