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A Model of the Federal Funds Market: Yesterday, Today, and Tomorrow

Author

Listed:
  • Gara Afonso

    (Federal Reserve Bank of New York)

  • Roc Armenter

    (Federal Reserve Bank of Philadelphia)

  • Benjamin Lester

    (Federal Reserve Bank of Philadelphia)

Abstract

The landscape of the federal funds market changed drastically in the wake of the Great Recession as large-scale asset purchase programs left depository institutions awash with reserves, and new regulations made it more costly for these institutions to lend. As traditional levers for implementing monetary policy became less effective, the Federal Reserve introduced new tools to implement the target range for the federal funds rate, changing this landscape even more. In this paper, we develop a model that is capable of reproducing the main features of the federal funds market, as observed before and after 2008, in a single, unified framework. We use this model to quantitatively evaluate the evolution of interest rates and trading volume in the federal funds market as the supply of aggregate reserves shrinks. We find that these outcomes are highly sensitive to the dynamics of the distribution of reserves across banks. (Copyright: Elsevier)

Suggested Citation

  • Gara Afonso & Roc Armenter & Benjamin Lester, 2019. "A Model of the Federal Funds Market: Yesterday, Today, and Tomorrow," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 177-204, July.
  • Handle: RePEc:red:issued:18-293
    DOI: 10.1016/j.red.2019.04.004
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    References listed on IDEAS

    as
    1. Ennis, Huberto M., 2018. "A simple general equilibrium model of large excess reserves," Journal of Monetary Economics, Elsevier, vol. 98(C), pages 50-65.
    2. Marvin Goodfriend, 1986. "A weekly rational expectations model of the nonborrowed reserve operating procedure," Economic Review, Federal Reserve Bank of Richmond, issue Jan, pages 11-28.
    3. Roc Armenter & Benjamin Lester, 2017. "Excess Reserves and Monetary Policy Implementation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 212-235, January.
    4. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March.
    5. William Poole, 1968. "Commercial Bank Reserve Management In A Stochastic Model: Implications For Monetary Policy," Journal of Finance, American Finance Association, vol. 23(5), pages 769-791, December.
    6. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
    7. Bech, Morten L. & Klee, Elizabeth, 2011. "The mechanics of a graceful exit: Interest on reserves and segmentation in the federal funds market," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 415-431.
    8. Whitesell, William, 2006. "Interest rate corridors and reserves," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1177-1195, September.
    9. Adam B. Ashcraft & Darrell Duffie, 2007. "Systemic Illiquidity in the Federal Funds Market," American Economic Review, American Economic Association, vol. 97(2), pages 221-225, May.
    10. Akihiko Matsui & Takashi Shimizu, 2005. "A Theory Of Money And Marketplaces," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(1), pages 35-59, February.
    11. Huberto Ennis & John Weinberg, 2013. "Over-the-counter loans, adverse selection, and stigma in the interbank market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(4), pages 601-616, October.
    12. Bech, Morten & Keister, Todd, 2017. "Liquidity regulation and the implementation of monetary policy," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 64-77.
    13. Ihrig, Jane E. & Kim, Edward & Kumbhat, Ashish & Vojtech, Cindy M. & Weinbach, Gretchen C., 2017. "How Have Banks Been Managing the Composition of High-Quality Liquid Assets?," Finance and Economics Discussion Series 2017-092, Board of Governors of the Federal Reserve System (US), revised 15 Feb 2018.
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    Cited by:

    1. repec:red:issued:19-0 is not listed on IDEAS
    2. Schulhofer-Wohl, Sam & Clouse, James A., 2018. "A Sequential Bargaining Model of the Fed Funds Market with Excess Reserves," Working Paper Series WP-2018-8, Federal Reserve Bank of Chicago.

    More about this item

    Keywords

    Monetary policy implementation; Federal funds market; Over-the-counter markets;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • 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

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