A number of recent efforts have been undertaken to modernize the Poole model by adding interest on reserves and other features of modern money markets. Two notable examples of this are Schulhofer-Wohl and Clouse (2018) and Afonso, Armenter, and Lester (2018). 17 Alternatively, it could be that banks are more efficient in their balance sheet management, which would be consistent with the lower volatility in overnight rates we have seen at recent quarter-ends. Bargaining dynamics within overnight money markets, which exhibit a fairly high degree of concentration of both borrowing and lending, could also have played a role in the rise over time in market rates relative to IOR. 18 For a further discussion of the shape of the demand curve for reserves and its implications for policy implementation, see Logan, “Operational Perspectives on Monetary Policy Implementation: Panel Remarks on The Future of the Central Bank Balance Sheet,” May 4, 2018. 19 In the spring there was an increase in borrowing in the federal funds market above IOR, but volume in the Eurodollar market decreased around the same time. 6  Let me offer some caveats to these observations. Money markets have been and are now changing quickly in response to regulatory, technology and business model incentives. 20 At the same time, reserves in the system have been abundant because of the asset purchase programs— perhaps smoothing through the effects of some of these changes.
Staff at the Federal Reserve has been using new data sets, analytics, and extensive market intelligence to deepen our understanding of the impact of these changes on money market dynamics. What follows is an illustration of this enhanced understanding. In the pre-crisis monetary policy framework, banks’ regulatory obligation to hold reserves was primarily driven by the required reserves framework, set forth in the Federal Reserve Act and Regulation D. 21 This framework involved banks meeting their requirement over a 14-day reserves maintenance period, as well as various other incentives that promoted short-term, but not extremely high-frequency, bank balance sheet management activity to maintain reserves at required levels—and the Federal Reserve had built analytics to provide good visibility into it. Today, while the Regulation D framework is still around, it is no longer likely to be the binding constraint on reserve levels for most large banks. 22 The new factors driving reserves demand appear to vary by financial institution, and seem to depend on a complex interplay of numerous new features of the financial system. On the regulatory side, these include the Liquidity Coverage Ratio (LCR), banks’ internal stress tests of their liquidity adequacy, supervisory expectations related to banks’ ability to monetize their liquidity portfolios during periods of financial stress, and the incorporation of liquidity into resolution planning. Other important factors include increased bank aversion to incurring intraday overdrafts, higher bank investor and creditor expectations for liquidity, and a lower opportunity cost of holding reserves relative to before the crisis.