This paper studies new monetary policy tools for managing short-term market rates.The tools we consider are interest on excess reserves (IOER), reverse repurchaseagreements (RRPs) with a wide range of market participants, and the term depositfacility (TDF).The Federal Reserve responded to the 2007-09 …nancial crisis and its aftermathwith a wide range of monetary policy measures that dramatically increased thesupply of reserves. In part, this has led the federal funds rate, and other moneymarket interest rates, to be more variable than before the crisis. In October 2008,the Federal Reserve began paying IOER to depository institutions (DIs). Since then,money market rates have consistently remained below the IOER rate. In June of 2011, the Federal Open Market Committee (FOMC) announced a strategy for thepossible use of new tools geared towards in‡uencing short-term market interest ratesand keeping them close to the IOER.
In August 2013, the FOMC also announced a…xed-rate, full-allotment overnight RRP (ON RRP) as one of these potential tools.
IOER is paid to DIs holding reserve balances at the Federal Reserve.
Termand ON RRPs provide a wide range of bank and non-bank counterparties with theopportunity to make the economic equivalent of collateralized loans to the FederalReserve. The TDF is a facility o¤ered to DIs, who are eligible to earn interest onbalances held in accounts at the Federal Reserve, that allows them to hold depositsfor longer term for an interest rate generally exceeding the IOER. An institutionalbackground and explanation of these tools is provided in Section 2.We develop a general equilibrium model of banking and money markets to studyhow the Federal Reserve can manage short-term market rates and the large level of reserves on its balance sheet using these tools. Our model extends Martin, McAn-drews, and Skeie (2013) (hereforth referred to as MMS) to include two separatebanking sectors, randomized relocation liquidity shocks occurring in an interim pe-riod, and interbank lending frictions. The model provides a framework within whichto study the e¤ectiveness of IOER, the term and ON RRP and the TDF in support-ing interest rates, and provides insight into the economic mechanisms that determinethe equilibrium rates and quantities.In our model, when banks are subject to balance sheet costs as in MMS, a with-drawal by depositors (caused by a "liquidity shock") must be redeposited in other
IOER di¤ers from interest on reserves (IOR) in that IOER is paid to reserve holdings in excessof the reserve requirement.