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Interbank payments and the daily federal funds rate

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  • Craig Furfine
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    Abstract

    This paper develops a model of bank reserve management and federal funds rate determination that incorporates the role of interbank payments. In the model, uncertainty in the receipt of payments generates a precautionary demand for bank reserves as banks face both reserve requirements and penalties for overnight overdrafts. Days with higher payment volume are assumed to create more uncertainty in a bank's reserve account that accentuates this precautionary motive. As a result, upward pressure is placed on the equilibrium funds rate. Implications of the model are then estimated using a panel of large banking institutions. Using the parameter estimates, simulations of the model suggest that patterns in payment activity explain many intra-maintenance period movements in both the level and volatility of the federal funds rate.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1998-31.

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    Date of creation: 1998
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    Handle: RePEc:fip:fedgfe:1998-31

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    Keywords: Federal funds market (United States) ; Bank reserves;

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    1. Kopecky, Kenneth J. & Tucker, Alan L., 1993. "Interest rate smoothness and the nonsettling-day behavior of banks," Journal of Economics and Business, Elsevier, vol. 45(3-4), pages 297-314.
    2. Paul Bennett & Spence Hilton, 1997. "Falling reserve balances and the federal funds rate," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 3(May).
    3. John Y. Campbell, 1986. "Money Announcements, the Demand for Bank Reserves and the Behavior of the Federal Funds Rate Within the Statement Week," NBER Working Papers 1806, National Bureau of Economic Research, Inc.
    4. Stuart E. Weiner, 1992. "The changing role of reserve requirements in monetary policy," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 45-63.
    5. Lasser, Dennis J., 1992. "The effect of contemporaneous reserve accounting on the market for federal funds," Journal of Banking & Finance, Elsevier, vol. 16(6), pages 1047-1056, December.
    6. Jeffrey A. Miron & Christina D. Romer & David N. Weil, 1994. "Historical Perspectives on the Monetary Transmission Mechanism," NBER Chapters, in: Monetary Policy, pages 263-306 National Bureau of Economic Research, Inc.
    7. Ben S. Bernanke & Ilian Mihov, 1995. "Measuring Monetary Policy," NBER Working Papers 5145, National Bureau of Economic Research, Inc.
    8. Joshua N. Feinman, 1993. "Reserve requirements: history, current practice, and potential reform," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jun, pages 569-589.
    9. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
    10. Spindt, Paul A. & Hoffmeister, J. Ronald, 1988. "The Micromechanics of the Federal Funds Market: Implications for Day-of-the-Week Effects in Funds Rate Variability," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 23(04), pages 401-416, December.
    11. Brunner, Allan D & Lown, Cara S, 1993. "The Effects of Lower Reserve Requirements on Money Market Volatility," American Economic Review, American Economic Association, vol. 83(2), pages 199-205, May.
    12. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
    13. Gordon H. Sellon, Jr. & Stuart E. Weiner, 1996. "Monetary policy without reserve requirements: analytical issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 5-24.
    14. Ho, Thomas S Y & Saunders, Anthony, 1985. " A Micro Model of the Federal Funds Market," Journal of Finance, American Finance Association, vol. 40(3), pages 977-88, July.
    15. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March.
    16. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    17. Griffiths, Mark D. & Winters, Drew B., 1995. "Day-of-the-week effects in federal funds rates: Further empirical findings," Journal of Banking & Finance, Elsevier, vol. 19(7), pages 1265-1284, October.
    18. Feinman, Joshua N, 1993. "Estimating the Open Market Desk's Daily Reaction Function," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 231-47, May.
    19. Heidi Willmann Richards, 1995. "Daylight overdraft fees and the Federal Reserve's payment system risk policy," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 1065-1077.
    20. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February.
    21. James A. Clouse & Douglas W. Elmendorf, 1997. "Declining required reserves and the volatility of the federal funds rate," Finance and Economics Discussion Series 1997-30, Board of Governors of the Federal Reserve System (U.S.).
    22. Eagle, David, 1995. "Federal-funds-rate volatility and the reserve-maintenance period," Review of Financial Economics, Elsevier, vol. 4(2), pages 157-170.
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    Cited by:
    1. Jeffrey M. Wrase, 1998. "Is the Fed being swept out of (monetary) control?," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-12.
    2. Välimäki, Tuomas, 2001. "Fixed rate tenders and the overnight money market equilibrium," Research Discussion Papers 8/2001, Bank of Finland.
    3. Clouse, James A. & Dow, James Jr., 2002. "A computational model of banks' optimal reserve management policy," Journal of Economic Dynamics and Control, Elsevier, vol. 26(11), pages 1787-1814, September.
    4. Eduardo Jallath-Coria & Tridas Mukhopadhyay & Amir Yaron, 2002. "How Well Do Banks Manage Their Reserves?," NBER Working Papers 9388, National Bureau of Economic Research, Inc.
    5. Fumio Hayashi, 2000. "Is There a Liquidity Effect in the Japanese Market?," Harvard Institute of Economic Research Working Papers 1898, Harvard - Institute of Economic Research.

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