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Consequently, rates in the federal funds market would be expected to be greater than or equal to the rate paid on excess reserve balances.
"On balance, we read the evidence as indicating that interest paid on excess reserve balances (or the equivalent) can be used by a central bank to tighten monetary policy and reduce reliance on supporting operations to drain reserves."
In estimating that demand, the Desk must take account of the demand for the three types of balances held by depository institutions at the Federal Reserve--required reserve balances, contractual clearing balances, and excess reserve balances.
To get a basic idea of how excess reserve demand can be inferred from excess reserve behavior, I will abstract for a moment from the current institutional structure and imagine the demand for excess reserves in a one-day maintenance period.
Where the central bank pays interest on excess reserves at rates in excess of the discount rate, commercial banks have an incentive to finance large excess reserve positions with discount borrowings.
Such an approach is problematic since the effect of total reserve changes is also influenced by changes in excess reserves. This failure to segregate changes in required reserves from excess reserve changes obscures the effects of ERR changes.
--(2017b) "Why Pay Interest on Excess Reserve Balances?" Liberty Street Economics blog, Federal Reserve Bank of New York (September 27).
Until the Fed ends its ongoing asset purchases, banks will likely continue to increase their excess reserve holdings.
primarily by adjusting the interest rate it pays on excess reserve balances." The implication is that banks will be encouraged to maintain higher levels of excess reserves than they otherwise might, thereby cushioning the reduction and potential translation into broad money expansion that could occur as interest rates rise in the economy.
Excess Reserve Holdings by Region Domestic European- Non-European Total Excess Banks Owned Banks Foreign-Owned Banks Reserves 2014:Q1 1.8033 0.7617 0.3652 2.9301 2014:Q2 1.8222 0.7298 0.4112 2.9631 2014:03 1.8972 0.7273 0.4100 3.0344 2014:Q4 1.8981 0.5767 0.3788 2.8535 2015:Q1 1.9849 0.5265 0.4040 2.9154 Source: Quarterly call report data.
"The increase in volume of borrowers acquiring FHA-backed loans will also contribute to the solvency of FHA's Mutual Mortgage Insurance Fund which is already on track to meet the 2% excess reserve amount required by Congress," Polychron said.