Federal Reserve Tools for Managing Rates and Reserves

Antoine Martin, James McAndrews (), Ali Palida and David Skeie
Additional contact information
Ali Palida: Federal Reserve Bank of New York (E-mail: ali.palida@ny.frb.org)

No 15-E-08, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: Monetary policy measures taken by the Federal Reserve as a response to the 2007-09 financial crisis and subsequent economic downturn led to a large increase in the level of outstanding reserves. The Federal Open Market Committee (FOMC) has a range of tools to control short-term market interest rates in this situation. We study several of these tools, namely interest on excess reserves (IOER), reverse repurchase agreements (RRPs), and the term deposit facility (TDF). We find that overnight RRPs (ON RRPs) provide a better floor on rates than term RRPs because they are available to absorb daily liquidity shocks. Whether the TDF or RRPs best support equilibrium rates depends on the relative intensity of the frictions that banks face, which are bank balance sheet costs and interbank monitoring costs in our model. We show that when both costs are large, using the RRP and TDF concurrently most effectively raises short- term rates. While public money supplied by the Federal Reserve in the form of reserves can alleviate bank liquidity shocks by reducing interbank lending costs, large levels of reserve increase banks' balance sheet size and can induce greater bank moral hazard. RRPs can reduce levels of costly bank equity that banks are endogenously required to hold as a commitment device against risk-shifting returns on assets.

Keywords: monetary policy; fixed-rate full allocation overnight reverse repurchases; term deposit facility; interest on excess reserves; FOMC; banking (search for similar items in EconPapers)
JEL-codes: E42 E43 G12 G20 (search for similar items in EconPapers)
Date: 2015-07
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (21)

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Working Paper: Federal Reserve tools for managing rates and reserves (2013)
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