Gara Afonso, Kyungmin Kim, Antoine Martin, Ed Nosal, Simon Potter, and Sam Schulhofer-Wohl
Working Paper 2023-10
August 2023

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We offer a parsimonious model of the reserve demand to study the tradeoffs associated with various monetary policy implementation frameworks. Prior to the 2007–09 financial crisis, many central banks supplied scarce reserves to execute their interest-rate policies. In response to the crisis, central banks undertook quantitative-easing policies that greatly expanded their balance sheets and, by extension, the amount of reserves they supplied. When the crisis and its aftereffects passed, central banks were in a position to choose a framework that has reserves that are (1) abundant—by keeping their balance sheets and reserves at the expanded level; (2) scarce—by vastly decreasing their balance sheets and reserves; or (3) somewhere in between abundant and scarce—by moderately decreasing their balance sheets and reserves. We find that the best policy implementation outcomes are realized when reserves are somewhere between scarce and abundant. This outcome is consistent with the Federal Open Market Committee’s 2019 announcement to implement monetary policy in a regime with an ample supply of reserves.

JEL classification: E42, E58

Key words: federal funds market, monetary policy implementation, ample reserves

The authors thank Jim Clouse, Spence Krane, Laura Lipscomb, Lorie Logan, Julie Remache, Zeynep Senyuz, Nate Wuerffel, and Patricia Zobel for useful comments. Potter worked on this paper while he was at the Federal Reserve Bank of New York and not subsequently. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Gara Afonso, the Federal Reserve Bank of New York; Kyungmin Kim, the Federal Reserve Board; Antoine Martin, the Federal Reserve Bank of New York; Ed Nosal, the Federal Reserve Bank of Atlanta; Simon Potter, Millennium Management; or Sam Schulhofer-Wohl, the Federal Reserve Bank of Dallas.

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