The Federal Reserve Act provides the Federal Reserve with the authority to pay interest on reserves (IOR). In Regulation D, the Board of Governors implemented this authority in the form of two rates: interest on required reserves (IORR), and interest on excess reserves (IOER). Since late 2008, these two rates have been set to the same value. 15  5  reserves. 16 These models generally find that as reserve balances decline, the overnight interest rate goes up, but not uniformly. At high levels of reserves, the responsiveness of rates to changes in reserve levels is fairly low, and the demand curve is said to be “flat.” As excess reserve levels decline, the responsiveness of rates increases. At low levels of excess reserves, the overnight rate responds sharply to small adjustments in the level of reserves: the demand curve is “steep.” It seems highly likely that we are on the “flat” part of the curve, the part where rates move little in response to shifts in reserves. But this does not quite answer the question on whether the decline in reserves might be putting perhaps some upward pressure on rates. Even in the “flat” part, the slope of the demand curve, while small, might be nonzero. This could be true if, for example, the balance sheet costs of the marginal borrower in overnight money markets were upward sloping with respect to that bank’s balance sheet size.
3 The effective federal funds rate is calculated as a volume-weighted median of overnight federal funds transactions reported by banks on the FR 2420 Report of Selected Money Market Rates. The New York Fed publishes the EFFR for the prior business day, along with volumes and rate percentiles, on its website daily at approximately 9:00 a.m. Eastern Time. The EFFR is used as a measure of the typical fed funds transaction and is the way the New York Fed’s Open Market Trading Desk (the Desk) measures its success in meeting the directive on interest rate control from the FOMC. 1  confidence in its ability to appropriately control overnight interest rates over the period of normalization. I will then conclude with some comments on recent developments in broader money market rates, in particular U.S.-dollar LIBOR. U.S. term money market rates are of global significance, owing to the heavy use of the dollar outside the United States and the large stock of dollar-LIBOR-linked debt issued abroad. 4 The spread of LIBOR to overnight indexed swaps has fluctuated in recent years, along with similar term unsecured dollar borrowing rates, driven in part by the same factors influencing overnight rates but also by specific past regulatory and legislative changes that have impacted flows in term markets. Evidence, such as from the FX swaps market, suggests that dollar borrowing markets continue to function well. Policy Normalization Continues As Expected I’d like to start by taking stock of where we are with the normalization of monetary policy in the United States.