In the face of raising loan demand The Fed wants to assure that The Banks have sufficient excess reserves to allow them to make all the loans (buy all the notes) required to make people (and politicians) happy. The Fed cannot, however, purchase enough securities from banks to accomplish its objective. The Banks have only 175,000 M-oz. of securities. If the fed bought all of them, it would only raise The Banks' excess reserves to 175,000 R-oz.

To accomplish its objective to significantly raise the deposit (money) creating capacity of The Banks, The Fed brings out the big cannon: the required reserve ratio.

The Fed reduces the required reserve ratio from 40% to 5%. (If a change from 40% to 5% seems extreme, consider that the actual effective reserve requirement amounts to less than 1%. See a discussion in the addendum.)

Let's see what happens.

Notice that without trading any assets (hard or otherwise), without incurring any new debt, without any workers having to save anything, banks have gone from possibly having to call loans, to having the capacity to buy an additional 5,687,500 M-oz. of notes. (Calculated by dividing the excess reserves by the required reserve ratio: 284,375 ÷ .05 = 5,687,500.)

The reserve ratio truly proves its power as a tool for The Fed to manage bank reserve balances. But, that's not enough for The Fed. They want borrowers to have access to even more money.