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Interest on reserves and Federal Reserve unwinding

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  • Dutkowsky, Donald H.
  • VanHoose, David D.

Abstract

This paper investigates the effects of reductions in the Federal Reserve’s asset portfolio on bank lending in the context of the Dutkowsky-VanHoose model of interest on reserves and regime shifts. Based upon relative magnitudes of structural resource cost parameters, we argue that retail lending becomes considerably less responsive to exogenous monetary base changes in the post-October 2008 regime of positive excess reserves and virtually zero wholesale lending. The model provides an explanation for the observed relationship between retail loans and the monetary base before and after October 2008. Our analysis indicates that the Fed can unwind its balance sheet with minimal disruption in retail lending, as long as it continues settings of the federal funds rate and the interest rate on reserves so that banks operate in the post-October 2008 regime. However, unwinding while returning to the pre-October 2008 regime of zero excess reserves and positive wholesale loans could lead to more adverse effects on retail lending.

Suggested Citation

  • Dutkowsky, Donald H. & VanHoose, David D., 2018. "Interest on reserves and Federal Reserve unwinding," Journal of Economics and Business, Elsevier, vol. 97(C), pages 28-38.
    • Handle: RePEc:eee:jebusi:v:97:y:2018:i:c:p:28-38
    DOI: 10.1016/j.jeconbus.2018.02.002
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    1. Dutkowsky, Donald H. & VanHoose, David D., 2020. "Equal treatment under the Fed: Interest on reserves, the federal funds rate, and the ‘Third Regime’ of bank behavior," Journal of Economics and Business, Elsevier, vol. 107(C).
    2. Enzo Dia & David VanHoose, 2022. "Unconventional-Policy Spillovers of U.S. Interest on Reserves within Global Dollar-Denominated Retail Loan and Deposit Markets," CRANEC - Working Papers del Centro di Ricerche in Analisi economica e sviluppo economico internazionale crn2203, Università Cattolica del Sacro Cuore, Centro di Ricerche in Analisi economica e sviluppo economico internazionale (CRANEC).
    3. Fegatelli, Paolo, 2022. "A central bank digital currency in a heterogeneous monetary union: Managing the effects on the bank lending channel," Journal of Macroeconomics, Elsevier, vol. 71(C).
    4. Jordan, Jerry L. & Luther, William J., 2022. "Central bank independence and the Federal Reserve's new operating regime," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 510-515.
    5. Cutsinger, Bryan P. & Luther, William J., 2022. "Seigniorage payments and the Federal Reserve’s new operating regime," Economics Letters, Elsevier, vol. 220(C).
    6. Hogan, Thomas L., 2021. "Bank lending and interest on excess reserves: An empirical investigation," Journal of Macroeconomics, Elsevier, vol. 69(C).
    7. Dutkowsky, Donald H. & VanHoose, David D., 2018. "Breaking up isn’t hard to do: Interest on reserves and monetary policy," Journal of Economics and Business, Elsevier, vol. 99(C), pages 15-27.

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    More about this item

    Keywords

    Interest on reserves; Federal funds rate; Bank lending; Monetary base; Federal Reserve unwinding;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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