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How Central Banks Use Reserve Requirements as a Policy Tool
Description
In Episode 25 of Monetary Policy Explained with Fexingo, Lucas and Luna dive into the central bank tool that doesn't get enough airtime: reserve requirements. They start with a concrete anchor — China's central bank just cut its reserve requirement ratio by 25 basis points in May 2026 — and explore why reserve requirements have fallen out of favor in advanced economies while remaining active in emerging markets. The hosts break down the mechanics: how changing the percentage of deposits banks must hold can expand or contract the money supply, the trade-off between control and market distortion, and the surprising fact that the US Federal Reserve still sets a reserve requirement but it's effectively zero. Lucas explains why the ECB and Bank of Japan have moved to zero requirements, while Luna points out that India and Brazil still use them actively. The episode also touches on the political appeal of reserve requirements as a 'tax' on banks, and why modern central bankers prefer interest rates as their primary tool despite the elegance of reserve ratios. A concrete, focused look at a tool that shaped monetary policy for decades.