Working Paper

Declining required reserves and the volatility of the federal funds rate.

Abstract: 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.

Keywords: Bank reserves; Federal funds rate;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 1997

Number: 1997-30