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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Interbank Payments and the Daily Federal Funds Rate
Craig Furfine

Abstract: This paper develops a model of bank reserve management and federal funds rate determination that incorporates the role of interbank payments. In the model, uncertainty in the receipt of payments generates a precautionary demand for bank reserves as banks face both reserve requirements and penalties for overnight overdrafts. Days with higher payment volume are assumed to create more uncertainty in a bank's reserve account that accentuates this precautionary motive. As a result, upward pressure is placed on the equilibrium funds rate. Implications of the model are then estimated using a panel of large banking institutions. Using the parameter estimates, simulations of the model suggest that patterns in payment activity explain many intra-maintenance period movements in both the level and volatility of the federal funds rate.

Keywords: Federal funds rate, payments, bank reserves

Full paper (1720 KB PDF)

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Last update: August 25, 1998