Interest on Reserves and Daylight Credit by Huberto M. Ennis and John A. Weinberg
Congress passed a law last year that allows the Federal Reserve to pay interest on balances held by depository institutions at the central bank. The implications for the demand for reserves, and by extension, monetary policy, may be significant. At present, banks face opportunity costs for holding reserves overnight at the Fed, since their funds might be able to earn interest if deployed elsewhere. During the daytime, banks weigh the tradeoff of holding as few reserves as possible with the costs of obtaining intraday credit from the Fed to meet their payment obligations. By 2011, when the new law takes effect, the incentives for these choices will be different. Since effective monetary policy may depend on predictable demand for reserves, understanding how these new incentives alter banks' decisions about reserve holdings may be useful. Richmond Fed economists Huberto Ennis and John Weinberg build a model of the demand for reserves by banks and study the potential consequences of paying interest on reserves.
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Also in the Spring 2007 issue:
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