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Declining required reserves and the volatility of the federal funds rate

  • James A. Clouse
  • Douglas W. Elmendorf

Low required reserve balances in 1991 led to a sharp increase in the volatility of the federal funds rate, but similarly low balances in 1996 did not. This paper develops and simulates a microeconomic model of the funds market that explains these facts. We show that reductions in reserve balances increase the volatility of the federal funds rate, but that this relationship changes over time in response to observable changes in bank behavior. The model predicts that a continued decline in required reserves could increase funds-rate volatility significantly.

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File URL: http://www.federalreserve.gov/pubs/feds/1997/199730/199730abs.html
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File URL: http://www.federalreserve.gov/pubs/feds/1997/199730/199730pap.pdf
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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 1997-30.

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Date of creation: 1997
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Handle: RePEc:fip:fedgfe:1997-30
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  1. Van Hoose, David D., 1991. "Bank behavior, interest rate determination, and monetary policy in a financial system with an intraday federal funds market," Journal of Banking & Finance, Elsevier, vol. 15(2), pages 343-365, April.
  2. Peristiani, Stavros, 1994. "An empirical investigation of the determinants of discount window borrowing: a disaggregate analysis," Journal of Banking & Finance, Elsevier, vol. 18(1), pages 183-197, January.
  3. 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.
  4. 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.
  5. Ann-Marie Meulendyke, 1992. "Reserve requirements and the discount window in recent decades," Quarterly Review, Federal Reserve Bank of New York, issue Aut, pages 25-43.
  6. James A. Clouse, 1994. "Recent developments in discount window policy," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 965-977.
  7. 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.
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