te to financial stability and better economic performance by limiting the scope of financial disruptions and preventing their spread outside the financial sector. Modern financial systems are highly complex and interdependent and potentially vulnerable to wide-scale systemic disruptions, such as those that can occur during a plunge in stock prices. #The Federal Reserve can help to establish for the U.S. banking system and, more broadly, for the financial system a framework that reduces the potential for systemic disruptions. Moreover, if a threatening disturbance develops, the central bank can cushion its effects on financial markets and the economy by providing liquidity through its monetary policy tools. #MONETARY POLICY AND THE RESERVES MARKET The initial link between monetary policy and the economy occurs in the market for reserves. The Federal Reserve's policies influence the demand for or supply of reserves at banks and other depository institutions, and through this market, the effects of monetary policy are transmitted to the rest of the economy. Therefore, to understand how monetary policy is related to the economy, one must first understand what the reserves market is and how it works. Demand for Reserves The demand for reserves has two components: required reserves and excess reserves. All depository institutions-commercial banks, savings banks, savings and loan associations, and credit unions-must retain a percentage of certain types of deposits to be held as reserves. #The Federal Reserve under the Depository Institutions Deregulation and Monetary Control Act of 1980 sets the reserve requirements. At the end of 1993, 4,148 member banks, 6,042 nonmember banks, 495 branches and agencies of foreign banks, 61 Edge Act and agreement corporations, and 3,238 thrift institutions were subject to reserve requirements. Since the early 1990s, reserve requirements have been applied only to transaction deposits (basically, interest-beari...