A Simple Model of Voluntary Reserve Targets with Tolerance Bands

18 Pages Posted: 22 Oct 2019

See all articles by Garth Baughman

Garth Baughman

Board of Governors of the Federal Reserve System

Francesca Carapella

Board of Governors of the Federal Reserve System

Date Written: August, 2019

Abstract

This note presents a simplifed version of the model of voluntary reserve targets (VRT) developed in Baughman and Carapella (forthcoming), with a Walrasian interbank market. First, the model makes transparent the role of target setting in controlling the market rate. Second, the simplicity of the model allows for an analysis of the interaction between VRT and tolerance bands, which are a common tool for controlling rate variability. We find that the persistent overshooting of interbank rates observed during the Bank of England's experiment with VRT may derive from the interaction between target setting and tolerance bands, a new explanation relative to the literature. We also suggest a simple remedy.

Suggested Citation

Baughman, Garth and Carapella, Francesca, A Simple Model of Voluntary Reserve Targets with Tolerance Bands (August, 2019). FEDS Working Paper No. 2019-60, Available at SSRN: https://ssrn.com/abstract=3473044 or http://dx.doi.org/10.17016/FEDS.2019.060

Garth Baughman (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francesca Carapella

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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