A Public Finance Analysis of Multiple Reserve Requirements

Marco Espinosa-Vega and Steven Russell
Federal Reserve Bank of Atlanta
Working Paper 98-1
January 1998

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This paper analyzes multiple reserve requirements of the type that have been imposed by a number of developing countries. We show that previous theoretical work on this topic has not succeeded in providing a social welfare rationale for the existence of multiple reserve requirements: in the basic reserve requirements model, any allocation that can be supported by a multiple-reserves regime can also be supported by a single-bond reserve requirement. We go on to present extended versions of the model in which it is possible for a multiple-reserves regime to improve social welfare relative to any single-reserve (currency or bond) and/or deposit-tax regime. We demonstrate the empirical plausibility of our approach by providing a case study of Mexico, a country with extensive historical experience with multiple reserve requirements.

JEL classification: E5, E6, F3

Key words: multiple reserve requirements, developing countries, monetary policy

The authors are grateful for comments from Peter Rangazas, Bruce Smith, participants in seminars at the Federal Reserve Bank of Atlanta and the Chinese University of Hong Kong, and sessions at the 1996 annual meetings of the Society for Economic Dynamics and the Latin American Econometric Society. Finally, the authors are indebted to Rodolfo Padilla of the Banco de Mexico for his assistance in providing data. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Marco Espinosa-Vega, Federal Reserve Bank of Atlanta, 104 Marietta Street, NW, Atlanta, Georgia 30303-2713, 404/498-8630, marco.espinosa@atl.frb.org, and Steven Russell, Economics Department, 523 Cavanaugh Hall, IUPUI, 425 University Boulevard, Indianapolis, Indiana 46202-5140, shrusse@iupui.edu.