NY Fed chief unveils real-time reserves calculation framework

Real-time calculations based on a central bank’s balance sheet can provide early-warning signs of reserves transitioning from abundant to ample to scarce, argues the president of the Federal Reserve Bank of New York.

In a blogpost published on August 13 and co-authored by Gara Afonso, Domenico Giannone and Gabriele La Spada, John Williams says that calculating a transition from abundant to ample is difficult because banks’ demand for reserves changes over time.

The authors calculate the slope of the “reserve demand curve”. This, they say, shows by how many basis points the federal funds rate – the price at which banks are willing to trade reserves with one another – would change if aggregate reserves increased by the equivalent of 1% of banks’ total assets.

The authors estimate the daily slope of the curve over the past 15 years using data from the Fed’s balance sheet.

A curve that is close to but above zero indicates abundant reserves. The authors say the curve was at this level from 2012 to 2017, when reserves exceeded 13% of banks’ assets.

Where the slope is zero or mildly negative marks the transition point from abundant to ample. This is the point at which central banks have been targeting monetary policy since the global financial crisis.

From 2018 to 2019, the authors say, the slope became increasingly negative, which was “consistent with reserves first becoming ample and then approaching scarcity”.

The authors say their framework would have given warning signs of stressed reserve levels six months in advance of the money-market stress episode in September 2019.

They define ample as when the supply of reserves is sufficiently large that the fed funds rate is not materially sensitive to everyday changes in aggregate reserves.

They add: “In an ample reserve regime, the fed funds rate can respond to daily shocks, but the response must be small.”

Alternative variables

A follow-up blog by Afonso, La Spada and others argues that other variables can also provide an indication of the abundance, ampleness or scarcity of reserves.

These include the share of interbank payments settled after 5pm. As banks’ reserves decline, they are incentivised to settle payments later in the day to ensure they have sufficient reserves to settle all their transactions.

The authors add that “if banks’ ability to postpone outgoing payments is limited, they may increase their use of intraday credit provided by the Fed, known as daylight or intraday overdraft”.

US banks, the authors argue, also borrow in the federal funds market if they need short-term liquidity. As liquidity becomes more constrained and their reserves transition from abundant to ample, these banks borrow more from the fed funds market.

Lower reserves could also increase repurchase rates as the large banks that often act as repo intermediaries face tighter liquidity constraints.

These four measures, say the authors, can be looked at jointly to indicate when reserves transition from abundant to ample to scarce. The authors find that these measures have historically moved in concert with the previously calculated real-time curve.