Publication Date


Document Type


First Advisor

Campbell, Carl

Degree Name

Ph.D. (Doctor of Philosophy)

Legacy Department

Department of Economics


The Federal Reserve implemented a new monetary tool policy as it simultaneously conducted the first round of quantitative easing in 2008. At that time, the Fed began paying interest on a commercial bank's required and excess reserves in order to prevent the federal funds rate from falling to zero. Before quantitative easing, reserves were scarce enough for the federal funds rate to be determined by the supply and the demand for reserves. Consequently, the Fed would use open market operations to manipulate the federal funds rate, and thereby influence other market interest rates. When the Federal Open Market Committee decided to raise the federal funds rate in December, 2015, open market operations were no longer viable to effect the overnight rate. Following three rounds of quantitative easing in which the Fed created trillions of reserves from buying long term assets and mortgage backed securities, reserves became so ample that the federal funds rate fell to its lower zero bound. To restore control over the federal funds rate, the Fed began paying interest on excess reserves, which sets a floor interest rate below where the federal funds will not trade. Open market operations became ineffective because of the plethora of funds in the reserve market. A market with ample reserve causes the federal funds rate to fall to the zero lower bound. However, the interest on excess reserve rate can adjust the effective federal funds rate independently of the quantity of reserves.

In a regime of ample reserves, adjusting the interest on excess reserves rate became the Fed's preferred approach to adjusting short-term market interest rates. In order to compare the Federal Reserve's interest on reserve monetary policy tool with open market operations, this monograph develops a two-sector equilibrium model with interest on reserves in the banking sector. It also constructs structural vector autoregression models with empirical data including interest on reserves. The objective of this paper is to analyze the monetary policy transmission effects of the Federal Reserve's interest on reserve policy. Impulse response functions are applied to both the theoretical and empirical models. The estimated impulse response functions are then compared to the theoretical model's impulse response functions in order to see how well the model fits the data. This paper's model finds that both monetary policy tools have the same effect on macroeconomic aggregated variables.


71 pages




Northern Illinois University

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