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Do Changes in Reserve Balances Still Influence the Federal Funds Rate?

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  • Andrew Lee Smith

Abstract

Over the past decade, the implementaton of U.S. monetary policy has changed significantly. Rather than adjusting the quantity of reserves in the banking system, policymakers now primarily use the interest rate paid on reserve balances, the IOR rate, to bring the federal funds rate within the target range. However, the recent rise in the federal funds rate relative to the IOR rate has raised questions about the primary drivers of the spread between the federal funds rate and the IOR rate in the Federal Reserve?s new operating framework. {{p}} A. Lee Smith examines the role declining reserve balances have played in influencing the federal funds-IOR spread. He finds that declining reserve balances have placed upward pressure on the federal funds rate in recent years despite the payment of interest on reserve balances. His findings suggest that the funds rate may continue to move higher relative to the IOR rate as reserve balances decline, potentially motivating further adjustments to the implementation of U.S. monetary policy.

Suggested Citation

  • Andrew Lee Smith, 2019. "Do Changes in Reserve Balances Still Influence the Federal Funds Rate?," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 5-34.
    • Handle: RePEc:fip:fedker:00073
    DOI: 10.18651/ER/1q19Smith
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    File URL: https://www.kansascityfed.org/documents/494/2019-Do%20Changes%20in%20Reserve%20Balances%20Still%20Influence%20the%20Federal%20Funds%20Rate%3F.pdf
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    Citations

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    Cited by:

    1. Gara Afonso & Kyungmin Kim & Antoine Martin & Ed Nosal & Simon M. Potter & Sam Schulhofer-Wohl, 2020. "Monetary policy implementation with an ample supply of reserves," Working Paper Series WP-2020-02, Federal Reserve Bank of Chicago.
    2. Lu, Yundi & Valcarcel, Victor J., 2024. "A tale of two tightenings," Journal of Economic Dynamics and Control, Elsevier, vol. 166(C).
    3. Smith, A. Lee & Valcarcel, Victor J., 2023. "The financial market effects of unwinding the Federal Reserve’s balance sheet," Journal of Economic Dynamics and Control, Elsevier, vol. 146(C).
    4. Calomiris, Charles W. & Mason, Joseph R. & Wheelock, David C., 2023. "Did doubling reserve requirements cause the 1937–38 recession? New evidence on the impact of reserve requirements on bank reserve demand and lending," Journal of Financial Intermediation, Elsevier, vol. 56(C).
    5. Belongia, Michael T. & Ireland, Peter N., 2024. "The transmission of monetary policy shocks through the markets for reserves and money," Journal of Macroeconomics, Elsevier, vol. 80(C).

    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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