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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Declining Required Reserves, Funds Rate Volatility, and Open Market Operations
Selva Demiralp and Dennis Farley

Abstract: The standard view of the monetary transmission mechanism rests on the central bank's ability to manipulate the overnight interest rate by controlling the reserve supply. In the 1990s, there was a significant decline in the level of reserve balances in the U.S. accompanied at first by an increase in the funds rate volatility. However, following this initial rise, volatility declined. In this paper, we find evidence of a structural break in volatility. We then estimate a tobit model of the major types of temporary open market operations and conclude that there have been changes in the Desk's reaction function that played a major role in controlling volatility.

Keywords: Required reserves, open market operations, trading desk

Full paper (268 KB PDF)

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Last update: July 16, 2003