The reason commercial banks and thrifts usually hold only small amounts of excess reserves is because:
- The Fed pays very low interest on reserves. This discourages banks from holding excessive reserves since they could earn more by investing or lending out those funds.
- Holding excess reserves tends to boost interest rates and reduce investment. When banks have too many excess reserves, it can lead to a decrease in lending, which affects overall investment in the economy.
- The Fed constantly uses open-market operations to eliminate excess reserves. By buying and selling government securities, the Fed adjusts the level of reserves in the banking system, aiming to keep them at an optimal level to maintain stability.
In summary, commercial banks and thrifts prefer to keep minimal excess reserves due to low interest payments, potential negative impacts on interest rates and investment, and the Fed's actions to manage excess reserves.
