Commercial bank behavior is not adequately dealt with in existing macro models of the financial sector. The central role of a demand for excess reserves (or free reserves) function in models of the money supply process is particularly suspect. In this paper, i t is argued that changes in commercial bank behavior induced by alterations in economic and financial conditions and various banking regulations, along with the central bank's approach to policy, have combined to alter the excess reserve function and the relationship between bank reserves and the money supply. Empirical work presented suggests that the "'demand" for excess reserves has indeed undergone structural change. Thus, the study indicates that conventional approaches to commercial bank behavior and the demand for excess reserves need to be reworked.Regulations affecting commercial banks, the strategy of monetary policy, and commercial bank behavior have all changed significantly in recent years. Despite these transformations, little change is discernible in the paradigm employed in describing the linkages among the Federal Reserve, banks, and the public. The focus of the present paper is on one key part of the chain that links the above actorsthe demand for excess reservessince this behavioral relationship is the core of the money supply process described in models of the financial sector. The line of inquiry to be pursued in this paper concerns the effect of the above mentioned changes on the excess reserve relationship and thus the existing paradigm used to describe and analyze the money supply process.
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