SOURCE: Federal Reserve Bank of Richmond

July 09, 2007 16:04 ET

Richmond Fed's "Economic Quarterly" Examines Interest Payment on Banks' Reserves as an Alternative to Daylight Credit

"Interest on Reserves and Daylight Credit" by Huberto M. Ennis and John A. Weinberg

RICHMOND, VA--(Marketwire - July 9, 2007) - Congress passed a law last year that allows the Federal Reserve to pay interest on balances held by depository institutions at the central bank. The implications for the demand for reserves, and by extension, monetary policy, may be significant. At present, banks face opportunity costs for holding reserves overnight at the Fed, since their funds might be able to earn interest if deployed elsewhere. During the daytime, banks weigh the tradeoff of holding as few reserves as possible with the costs of obtaining intraday credit from the Fed to meet their payment obligations. By 2011, when the new law takes effect, the incentives for these choices will be different. Since effective monetary policy may depend on predictable demand for reserves, understanding how these new incentives alter banks' decisions about reserve holdings may be useful. Richmond Fed economists Huberto Ennis and John Weinberg build a model of the demand for reserves by banks and study the potential consequences of paying interest on reserves.

You can find the full text of this article and others in the latest issue of "Economic Quarterly" at:

Also in the Spring 2007 issue:

--  "How Accurate Are Real-Time Estimates of Output Trends and Gaps?" by
    Mark W. Watson
--  "The Economics of Sovereign Defaults" by Juan Carlos Hatchondo,
    Leonardo Martinez, and Horacio Sapriza
--  "Banks and Liquidity Creation: A Simple Exposition of the Diamond-
    Dybvig Model" by Douglas W. Diamond
The "Economic Quarterly" is a free publication containing economic analysis pertinent to Federal Reserve monetary and banking policy. For free copies or more information, contact the Federal Reserve Bank of Richmond's Public Affairs office at 804.697.7982.

The Federal Reserve Bank of Richmond is one of 12 District Reserve Banks that together with the Board of Governors in Washington, D.C., make up the Federal Reserve System. The Richmond Fed serves the Fifth Federal Reserve District, which encompasses the District of Columbia, Maryland, North Carolina, South Carolina, Virginia, and most of West Virginia.

Contact Information

  • Contacts:
    John A. Weinberg
    Director of Research
    Federal Reserve Bank of Richmond

    Kay Haynes
    Managing Editor
    Federal Reserve Bank of Richmond "Economic Quarterly"
    Email Contact