Abstract–Micro-Foundation of the Federal Funds Market

From an historical perspective, the Federal funds market has evolved from primarily a receptacle for residual funds into a leading money market. During the market's formative years, banks borrowed Federal funds strictly as a reserve adjustment measure to supplement their discount window borrowings. Gradually, money market pressures have created a situation in which banking institutions find it profitable to finance some of their loan expansions and to expedite various types of transactions with the temporary use of these funds. Consequently, banks have reversed their earlier views and are presently treating discounting as being subservient to the purchasing of Federal funds. Initially, banks lent only their idle reserves in the funds market. In due succession, the practice of selling Federal funds replaced call loans as the predominant secondary reserve and has presently grown into a leading liquid asset in many banks' portfolios. Paralleling this rapid expansion has been the diversification of the funds market. Presently, one-third of the total volume of funds in this market originate from institutions other than commercial banks, i.e. U. S. Government Security Dealers and large corporations. Not only have the number and types of participants enlarged, but they tend to participate continuously rather than on an occasional basis.