Why Do Central Banks Require Reserves?

“Over 90% of central banks oblige depository institutions(commercial banks) to hold minimum reserves against their liabilities, predominantly in the form of balances at the central bank. The role of these reserve requirements has evolved significantly over time. The overlay of changing purposes and practices has the result that it is not always fully clear what the current purpose of reserve requirements is, and this necessarily complicates thinking about how a reserve regime should be structured…..”

The IMF has produced a timely background paper that describes the three main purposes for reserve requirements – prudential, monetary control and liquidity management – and suggests best practice for the structure of a reserves regime. As well as discussing the use of reserves remuneration as a policy signal, the paper illustrates current practices using a 2010 IMF survey of 121 central banks.

Central Bank Balances and Reserve Requirements, IMF Working Paper, February 2011

DSGE Models & Expectations Management Policy

The FRBNY authors present and estimate a simple New Keynesian DSGE model, highlighting the core features that this basic specification shares with more elaborate versions. They then apply the estimated model to study the sources of the sudden increase in US inflation that occurred in the first half of 2004.
One important lesson derived from this exercise is that the management of expectations can be a more effective tool for stabilizing inflation than actual movements in the policy rate.
This result is consistent with the increasing use of forward guidance by central banks.
Policy Analysis Using DSGE Models: An Introduction, FRB New York, Oct 2010