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Tunnels and reserves in monetary policy implementation

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Author Info
William Whitesell
Abstract

In recent years, some central banks have implemented monetary policy without reserve requirements by using a ceiling and floor for overnight interest rates established by central bank lending and deposit facilities. This paper analyzes a theoretical model of such a "tunnel" system and the benefits of adding reserve requirements to it. However, reserve requirements may involve social costs owing to the reserve avoidance activities of banks. The paper also presents a modified model with no reserve avoidance, where banks optimally choose to hold voluntary reserve requirements. The paper highlights the importance for central banks to consider such models in light of idiosyncratic features of their own institutional environment, which may importantly condition the advisability of any particular approach. ; In recent years, some central banks have implemented monetary policy without reserve requirements by using a ceiling and floor for overnight interest rates established by central bank lending and deposit facilities. This paper analyzes a theoretical model of such a "tunnel" system and the benefits of adding reserve requirements to it. However, reserve requirements may involve social costs owing to the reserve avoidance activities of banks. The paper also presents a modified model with no reserve avoidance, where banks optimally choose to hold voluntary reserve requirements. The paper highlights the importance for central banks to consider such models in light of idiosyncratic features of their own institutional environment, which may importantly condition the advisability of any particular approach.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2003-28.

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Date of creation: 2003
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Handle: RePEc:fip:fedgfe:2003-28

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Keywords: Bank reserves ; Monetary policy;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
  2. Claudio E. V. Borio, 1997. "Monetary policy operating procedures in industrial countries," BIS Working Papers 40, Bank for International Settlements. [Downloadable!]
  3. Clouse, James A. & Dow Jr., James P., 1999. "Fixed costs and the behavior of the federal funds rate," Journal of Banking & Finance, Elsevier, vol. 23(7), pages 1015-1029, July. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
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  5. Christian Ewerhart, 2002. "A model of the Eurosystem's operational framework for monetary poicy implementation," Working Paper Series 197, European Central Bank. [Downloadable!]
  6. Heller, Daniel & Lengwiler, Yvan, 2003. "Payment obligations, reserve requirements, and the demand for central bank balances," Journal of Monetary Economics, Elsevier, vol. 50(2), pages 419-432, March. [Downloadable!] (restricted)
  7. Furfine, Craig H., 2000. "Interbank payments and the daily federal funds rate," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 535-553, October. [Downloadable!] (restricted)
  8. Kevin Clinton, 1997. "Implementation of Monetary Policy in a Regime with Zero Reserve Requirements," Working Papers 97-8, Bank of Canada. [Downloadable!]
  9. John Y. Campbell, 1987. "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. [Downloadable!] (restricted)
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  10. Michael Woodford, 2001. "Monetary policy in the information economy," Proceedings, Federal Reserve Bank of Kansas City, pages 297-370. [Downloadable!]
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  11. 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. [Downloadable!] (restricted)
  12. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84. [Downloadable!]
  13. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October. [Downloadable!] (restricted)
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  1. Yueh-Yun C. O’Brien, 2007. "Reserve requirement systems in OECD countries," Finance and Economics Discussion Series 2007-54, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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