Interest on Excess Reserves as a Monetary Policy Instrument: The Experience of Foreign Central Banks

Abstract

This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tightening that included increasing these policy rates been achieved without reliance on reductions in reserves or other deposits held at the central bank? The foreign experience suggests that policy rate floors can be effective lower bounds for market rates, although incomplete access to central bank accounts and interest on them weakens this result. In addition, the foreign experience suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances. These results are consistent with theoretical results that show that tightening without draining is possible, irrespective of whether excess reserves are large or small.

Corridor System and Interest Rates: Volatility and Asymmetry

“…Indeed, in a study of eight central banks operating under the corridor system, Bowman, Gagnon, and Leahy () found evidence that standing facilities had largely succeeded in containing upward and downward deviations from the policy rate. Despite its popularity, however, the theoretical framework underpinning this system has not been sufficiently explored.…”

“…A floor system may be viewed as a type of asymmetric corridor system (Bowman, Gagnon, and Leahy ). To avoid confusion, however, this article confines its discussion of asymmetric corridor systems to those cases where the policy rate is located between two standing facility rates.…”

The Impact of Return on Collateral in a Channel System

“…The money market rate coincides with the target rate for the most part of the data (see Figure ). As Bowman, Gagnon, and Leahy () and Hossain () pointed out, the main reason that the Reserve Bank of Australia (RBA) can keep the overnight market rate spot on the official target is due to the specific operation procedure that allows the RBA to know each participant's liquidity position better. The ability for the RBA gathering information from market participants has been enhanced greatly since 2002 due to technical progress.…”

“…The data set for each country consists of the lending rate, deposit rate, and target rate, except New Zealand and Australia whose central bank do not explicitly provide statistics on lending and deposit rate. However, they can be calculated with information from the central bank and other literature such as Bowman, Gagnon, and Leahy (). We also obtain data on the money market rate and the nominal return on government assets (collateral), in addition to inflation for each country.…”

The Over‐the‐Counter Theory of the Fed Funds Market: A Primer

“…They find a significant positive effect in Japan (August 16, 1985 to March 15, 2001), France (May 16, 1987 to June 30, 1994), and Italy (November 15, 1990 to December 14, 1998). In a more recent paper, Bowman, Gagnon, and Leahy () review episodes of monetary policy tightening through changes in the floor rate. In particular, they document events where several central banks (Bank of Canada, Norges Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, and Riksbank) raised interbank rates by increasing the interest rates paid on balances held at the central bank without decreasing aggregate balances.…”