Keywords: Monetary policy implementation, reserve requirements, overnight interest rates
Abstract: In recent years, some central banks have implemented monetary policy without
reserve requirements by using a ceiling and floor for overnight interest
rates established by central bank lending and deposit facilities. This paper
analyzes a theoretical model of such a "tunnel" system and the benefits of
adding reserve requirements to it. However, reserve requirements may involve
social costs owing to the reserve avoidance activities of banks. The paper also
presents a modified model with no reserve avoidance, where banks optimally
choose to hold voluntary reserve requirements. The paper highlights the
importance for central banks to consider such models in light of
idiosyncratic features of their own institutional environment, which
may importantly condition the advisability of any particular approach.
Full paper (469 KB PDF)
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Last update: October 22, 2003