Monetary policy transmission and bank reserves
In this paper, Fricke et al. show that when central bank reserves are ample and their remuneration rate is the (implicit) key policy rate, monetary policy transmission varies across banks’ levels of excess reserves. More specifically, the authors argue that when central banks increase rates materially, the net worth of reserve-rich banks may be positively affected because an increase in the reserve remuneration will boost net interest income. Therefore, reserve-rich banks may not have to contract their credit supply as strongly as other banks, at least in the short term. Fricke et al. use the AnaCredit dataset, a harmonized credit register for the entire euro area, and compare the credit supply of banks with different ex-ante reserve ratios before and after the start of ECB’s hiking cycle in July 2022. Their main findings are:
- On average, increasing the reserve ratio by one standard deviation from the mean, increases banks’ credit supply to non-financial firms by 1.28% after July 2022.
- Banks with reserve ratios above one standard deviation from the mean, this credit supply effect corresponds to between 0.16% and 0.28% of euro area GDP in 2022.
- If high reserve banks would have behaved exactly as other banks– aggregate credit volumes would have been 0.5% lower in February 2023.
Excess reserves and monetary policy tightening
Authors: Daniel Fricke, Stefan Greppmair, Karol Paludkiewicz
From: Deutsche Bundesbank
The optimal supply of reserves under uncertainty
In this paper, Afonso et al. develop an analytically tractable framework for studying the optimal supply of central bank reserves when demand is uncertain and nonlinear. They argue that greater uncertainty about the demand for reserves unambiguously raises the optimal supply. Their analysis relies on the assumption that the central bank faces a demand curve for reserves that links the quantity of reserves to the spread between the policy rate, implied by the market, and the interest rate on reserves. The optimal spread between the market and administered rates is not zero due to market frictions, and in this paper, the authors treat it as a parameter. The reserve demand function has three regions:
- For a scarce supply of reserves, the slope of the demand curve is steep, i.e., price elastic.
- For a sufficiently large, or ample, supply of reserves, the price-elasticity declines, i.e., the demand curve flattens but is still downward sloped.
- For an even larger, or abundant, supply of reserves, demand becomes completely price inelastic, i.e., the demand curve is flat.
The central bank is faced with uncertainty about the location of the kink between the ample and abundant regions (i.e., satiation point), about the minimum spread (i.e., the floor of the demand curve), and about the slope of the demand curve in the ample region. It is this uncertainty that drives the results of this paper:
We find that the optimal supply of reserves under uncertainty is greater than that absent uncertainty. With a sufficient degree of uncertainty, it is optimal to supply a level of reserves that is abundant (on the flat portion of the demand curve). The model captures the empirical observation that the variability of interest rate spreads depends on reserves supply.
The Optimal Supply of Central Bank Reserves under Uncertainty
Authors: Gara Afonso, Gabriele La Spada, Thomas M. Mertens, John C. Williams
From: Federal Reserve Bank of New York, Federal Reserve Bank of San Francisco
