Working Paper

Interbank payments and the daily federal funds rate

Abstract: This paper develops a model of bank reserve management and federal funds rate determination that incorporates the role of interbank payments. In the model, uncertainty in the receipt of payments generates a precautionary demand for bank reserves as banks face both reserve requirements and penalties for overnight overdrafts. Days with higher payment volume are assumed to create more uncertainty in a bank's reserve account that accentuates this precautionary motive. As a result, upward pressure is placed on the equilibrium funds rate. Implications of the model are then estimated using a panel of large banking institutions. Using the parameter estimates, simulations of the model suggest that patterns in payment activity explain many intra-maintenance period movements in both the level and volatility of the federal funds rate.

Keywords: Federal funds market (United States); Bank reserves;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 1998

Number: 1998-31