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Excess Reserves and Monetary Policy Normalization

Author

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  • Benjamin Lester

    (Federal Reserve Bank of Philadelphia)

  • Roc Armenter

    (Federal Reserve Bank of Philadelphia)

Abstract

We provide a framework to understand the factors affecting current short-term interest rates in the federal funds market given the presence of excess reserves and liquidity facilities. The key ingredients of our model are as follows. There is a central bank that operates two facilities: one pays interest on excess reserves to qualified depository institutions (DIs), and another provides a positive rate of return for overnight reverse repurchase agreements. The latter (ON RRP) rate is lower than the former (IOER) rate, but is available to financial institutions with excess cash that do not qualify as DIs. Hence, there is an arbitrage opportunity: DIs should be willing to borrow cash at a rate below the IOER rate and pocket the difference. However, there are two potential frictions in this inter-bank market. First, we assume that the market is not perfectly competitive, but rather characterized by search frictions in order to capture the ``over-the-counter'' nature of the fed funds market. The second key friction in our model is that DIs incur balance sheet costs when they accept deposits from lenders; these costs capture both the direct costs of a DI expanding its balance sheet, like FDIC fees, as well as the indirect costs associated with requirements on capital and leverage ratios.

Suggested Citation

  • Benjamin Lester & Roc Armenter, 2015. "Excess Reserves and Monetary Policy Normalization," 2015 Meeting Papers 586, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:586
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    References listed on IDEAS

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    1. 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.
    2. Marcelo Rezende & Mary-Frances Styczynski & Cindy M. Vojtech, 2016. "The Effects of Liquidity Regulation on Bank Demand in Monetary Policy Operations," Finance and Economics Discussion Series 2016-090, Board of Governors of the Federal Reserve System (U.S.).
    3. Stephen D. Williamson, 2015. "Interest on Reserves, Interbank Lending, and Monetary Policy," Working Papers 2015-24, Federal Reserve Bank of St. Louis.
    4. Guillaume Khayat, 2017. "The Corridor's Width as a Monetary Policy Tool," Working Papers halshs-01611650, HAL.
    5. Williamson, Stephen D., 2019. "Interest on reserves, interbank lending, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 101(C), pages 14-30.
    6. Borghan Narajabad, 2017. "ON RRP and Stability of the Tri-party Market," 2017 Meeting Papers 1151, Society for Economic Dynamics.
    7. Michael Boutros & Jonathan Witmer, 2017. "Monetary Policy Implementation in a Negative Rate Environment," Staff Working Papers 17-25, Bank of Canada.
    8. Arun G. Chandrasekhar & Robert Townsend & Juan Pablo Xandri, 2018. "Financial Centrality and Liquidity Provision," NBER Working Papers 24406, National Bureau of Economic Research, Inc.

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    More about this item

    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
    • 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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