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Allan Meltzer of Carnegie Mellon University wrote the following about how the Federal Reserve Board's staff analyzed the likely effects of the large excess reserves banks were holding in the mid-1930s: [The] Board's staff . . . [assumed] that none of the excess reserves were held for reasons of safety based on experience.
The result was a large overestimate of potential monetary and credit expansion and prospective inflation and an underestimate of the effect of higher reserve requirement ratios.
a. Why might banks in the mid-1930s have been holding reserves for "reasons of safety"?
b. What does Meltzer mean by "potential monetary and credit expansion"?
c. If banks were holding excess reserves for reasons of safety, why might the Fed's staff have been overestimating potential monetary and credit expansion?
d. What was the effect on banks of the Fed's decision to increase the required reserve ratio? What insight does Meltzer give into why the Fed's staff underestimated the effect of the increase?
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