IDEAS home Printed from https://ideas.repec.org/a/eee/jmacro/v54y2017ipbp208-216.html
   My bibliography  Save this article

Interest on reserves, settlement, and the effectiveness of monetary policy

Author

Listed:
  • Hendrickson, Joshua R.

Abstract

Over the last several years, the Federal Reserve has conducted a series of large scale asset purchases. The effectiveness of these purchases is dependent on the monetary transmission mechanism. Former Federal Reserve chairman Ben Bernanke argued that large scale asset purchases are effective because they induce portfolio reallocations that ultimately lead to changes in economic activity. Despite these claims, a large fraction of the expansion of the monetary base is held as excess reserves by commercial banks. Concurrent with the large scale asset purchases, the Federal Reserve began paying interest on reserves and enacted changes in its Payment System Risk policy. In this paper, I estimate the effect of the payment of interest on reserves (as well as other payment policy changes) on the demand for daylight overdrafts through Fedwire. Since Fedwire provides overdrafts at a fixed price, any fluctuation in the quantity of overdrafts is a change in demand. A reduction in overdrafts corresponds with an increase in the demand for reserves. I show that the payment of interest on reserves has had a negative and statistically significant effect on daylight overdrafts. Furthermore, I interpret these results in light of recent theoretical work. I argue that by paying an interest rate on excess reserves that is higher than comparable short term rates, the Federal Reserve likely hindered the portfolio reallocation channel outlined by Bernanke. Thus, the payment of interest on reserves increased payment processing efficiency, potentially at the expense of limiting the ability of monetary policy to influence economic activity.

Suggested Citation

  • Hendrickson, Joshua R., 2017. "Interest on reserves, settlement, and the effectiveness of monetary policy," Journal of Macroeconomics, Elsevier, vol. 54(PB), pages 208-216.
  • Handle: RePEc:eee:jmacro:v:54:y:2017:i:pb:p:208-216
    DOI: 10.1016/j.jmacro.2017.05.010
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S016407041730215X
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Morten L. Bech & Antoine Martin & James J. McAndrews, "undated". "Settlement liquidity and monetary policy implementation—lessons from the financial crisis," Economic Policy Review y:2012:i:mar:p:3-20:n:v.1, Federal Reserve Bank of New York.
    2. Joseph E. Gagnon & Matthew Raskin & Julie Remache & Brian P. Sack, "undated". "Large-scale asset purchases by the Federal Reserve: did they work?," Economic Policy Review y:2011:i:may:p:41-59:n:v., Federal Reserve Bank of New York.
    3. Dutkowsky, Donald H. & VanHoose, David D., 2017. "Interest on reserves, regime shifts, and bank behavior," Journal of Economics and Business, Elsevier, vol. 91(C), pages 1-15.
    4. Cochrane, John H., 2014. "Monetary policy with interest on reserves," Journal of Economic Dynamics and Control, Elsevier, vol. 49(C), pages 74-108.
    5. Stephen D. Williamson, 2012. "Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach," American Economic Review, American Economic Association, vol. 102(6), pages 2570-2605, October.
    6. 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.
    7. Stacy Panigay Coleman, "undated". "The evolution of the Federal Reserve's intraday credit policies," Federal Reserve Bulletin y:2002:i:feb:p:67-84:n:v., Board of Governors of the Federal Reserve System (U.S.).
    8. Ben S. Bernanke, 2010. "Opening remarks: the economic outlook and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 1-16.
    9. Brunner, Karl & Meltzer, Allan H, 1971. "The Uses of Money: Money in the Theory of an Exchange Economy," American Economic Review, American Economic Association, vol. 61(5), pages 784-805, December.
    10. Alchian, Armen A, 1977. "Why Money?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 9(1), pages 133-140, February.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dutkowsky, Donald H. & VanHoose, David D., 2018. "Interest on reserves and Federal Reserve unwinding," Journal of Economics and Business, Elsevier, vol. 97(C), pages 28-38.
    2. Glocker, Christian, 2019. "Do reserve requirements reduce the risk of bank failure?," MPRA Paper 95634, University Library of Munich, Germany.
    3. Nicolás Cachanosky & Alexander W. Salter, 2020. "The super-alertness of central banks," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 33(1), pages 187-200, March.
    4. Oxana Afanasyeva & Dmitriy Korovin, 2020. "The impact of reserve requirements of central banks on macroeconomic indicators," Entrepreneurship and Sustainability Issues, VsI Entrepreneurship and Sustainability Center, vol. 8(1), pages 413-429, September.

    More about this item

    Keywords

    Monetary policy; Interest on reserves; Daylight overdrafts; Settlement;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jmacro:v:54:y:2017:i:pb:p:208-216. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Haili He). General contact details of provider: http://www.elsevier.com/locate/inca/622617 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.