Finance and Economics Discussion Series (FEDS)
July 1997
Declining Required Reserves and the Volatility of the Federal Funds Rate
James A. Clouse and Douglas W. Elmendorf
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.
Full paper (372 KB Postscript)Keywords: Reserve requirements, federal funds rate, volatility
PDF: Full Paper
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