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Review of Political Economy, Vol. 16, No. 1, 43–58, January 2004 Asset-based Reserve Requirements: Reasserting Domestic Monetary Control in an Era of Financial Innovation and Instability THOMAS I. PALLEY Thomas I.PalleyOpen Society Institute1120 Nineteenth NW, 8th FloorWashingtonDC20036USA Open Society Institute, Washington, USA ABSTRACT This paper argues for developing a new system of financial regulation based upon asset-based reserve requirements (ABRRs). Such a system represents a shift in regulatory focus away from the traditional concern with the liability side of financial intermediaries’ balance sheets. ABRRs have both significant macroeconomic and mi- croeconomic advantages. At the macroeconomic level, they can provide policy makers with additional policy instruments. This is particularly useful in light of recent concerns about the dangers of asset price inflation and the potential need to target asset prices. They can also help restore the traction of monetary policy at a time when banks are becoming a smaller part of the financial landscape. At the microeconomic level, they can be used to discourage excessive risk taking by financial intermediaries. Finally, they can also raise considerable seignorage. To be fully effective, a system of ABRRs should be applied to all financial intermediaries. 1. A New Proposal: Asset-based Reserve Requirements The last two decades have witnessed significant financial innovation within the US economy. One important innovation has been reduced reliance on traditional bank deposits, and here the driving forces have been the spread of money market mutual funds and the growth of the commercial paper market. This change in the significance of bank deposits is captured in Tables 1 and 2. Table 1 shows that bank deposits fell from 25% of household financial assets in 1979 to 10% in 1999. Table 2