What are Lagged Reserves?
How Do Lagged Reserves Work?
The United States Federal Reserve regulates the U.S. banking industry as the country's central bank. Many of these regulations concern the amount of physical cash a given bank is required to keep on hand and at what point the bank is forced to borrow funds from another bank.
The system of lagged reserves is a U.S. federal directive that requires a bank's currency reserves held with the Federal Reserve at any given time be equal to the value of its demand deposit (checking) accounts 14 days earlier. For example, if all of a bank's demand deposits were equal to $5 million on April 17, its currency reserves would need to equal $5 million on May 1.
Why Do Lagged Reserves Matter?
The Federal Reserve policy used lagged reserves from the 1960s until the mid-1980s. After briefly using the contemporaneous reserves method from the mid-1980s to mid-1990s, it reinstated the lagged reserves policy after realizing that it was more accurate.