Banks’ strongReservestrong Management, Transaction Costs, and the Timing.pdfVIP

Banks’ Reserve Management, Transaction Costs, and the Timing of Federal Reserve Intervention Leonardo Bartolini,a Giuseppe Bertola,b and Alessandro Prati c a Federal Reserve Bank of New York (New York, NY 10045, USA) b European University Institute (S. Domenico di Fiesole, I-500 16, Italy), U. di Torino, and CEPR c International Monetary Fund (Washington, DC 20431, USA) November 1999 * Abstract We use daily data on bank reserves and overnight interest rates to document a striking pattern in the high-frequency behavior of the U.S. market for federal funds: depository institutions tend to hold more reserves during the last few days of each “reserve maintenance period,” when the opportunity cost of holding reserves is typically highest. We then propose and analyze a model of the federal funds market where uncertain liquidity flows and transactions costs induce banks to delay trading and to bid up interest rates at the end of each maintenance period. In this context, the central bank ’s interest-rate-smoothing policy causes a high supply of liquid funds to be associated with high interest rates around reserve settlement days. JEL G2 1, E52. Keywords: reserve requirements, interest-rate smoothing, value of waiting. Address: Giuseppe Bertola, Dept. of Economics, IUE, I-50016 San Domenico di Fiesole FI x39-055-4685225, bertola@datacomm.iue.it * We thank S. Hilton, S. Krieger, J. Partlan, and E. Spinner, from the Federal Reserve’s Open Market Desk, for useful discussion and for granting us access to the Federal Reserve Bank of New York ’s reserve data archive; J. Clouse, from the Federal Reserve Board, for sharing with us detai