Fed blog: What Quantity of Reserves Is Sufficient?

Adam Copeland, Darrell Duffie, and Yilin (David) Yang

A concern of the Federal Reserve is how to manage its balance sheet and whether, over the long run, the balance sheet should be small or large. In this post, we highlight results from a recent paper in which we show how, even during a period of “ample” reserves, the Fed’s management of its balance sheet had material impacts on funding markets and especially the repo market. We argue that the Fed’s “balance-sheet normalization” from March 2017 to September 2019—under which aggregate reserves declined by more than $950 billion—combined with post-crisis liquidity regulations, stressed the intraday management of reserves of large bank holding companies that are active in wholesale funding markets resulting in higher repo rates and spikes in such.

Before the 2007-09 crisis, the Fed provided a small aggregate supply of reserves, typically under $50 billion. This was sufficient for banks to manage their intraday liquidity demands and for wholesale funding markets to function with reasonable efficiency. With the Fed’s crisis facilities and post-crisis quantitative easing programs, aggregate reserves increased substantially, hitting $2.8 trillion in 2014.

By itself, such a large increase in reserves would make it easier for banks to manage their intraday liquidity constraints and provide funding to others. But as part of post-crisis regulatory reform, the Fed also introduced several liquidity requirements that provided incentives for large bank holding companies to hold substantial reserve balances at the Fed throughout each day. The level of reserves necessary to maintain liquid funding markets and meet intraday payment needs was difficult to determine.

The full article is available at https://libertystreeteconomics.newyorkfed.org/2021/09/what-quantity-of-reserves-is-sufficient/ 

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