What it is:
How it works (Example):
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 it Matters:
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.