Jourczl of Monetary Economics 10 (19811 M-405. North-Holland Publishing Company COMMERCIAL BANK BEHAVIOR AND MONETARY K?LICy ’ 1B AN OPEN ECONOMY

This paper studies movements in the ratio of free liquid reserves of West German commercial banks to total deposits over the period 1960-1980. The desired ratio is assumed lo depend positivdy on the ‘own yield’, measured by recently experienced variance of the required-reserve ratio (ir proxy for portfolio adjustment costs avoided by holding free reserves), and negatively on the yield on alternative assets. The observed free reserve ratio also responds to changes in the Bundesbank’s hokiiigs of foreign exchange and net government deposits. Empirical tests on quarttiy data support tbe hypothesis though behavioral shifts occurred in 1966 and 1973. In examining the money sipply process and the functioning of monetary policy in the Federal Republic of Germany in the last twenty years, the free liquid reserves of commercial banks are of central importance. Factors leading banks to adjust heir desired level of free reserves relative to deposits, as well as those inflwnces causing the actual free merve ratio to deviate from its de&cd level, result ceterris paribus in money stock changes. Furthermore, the Bundesbank has r!garded the commercial banks ’ reserve position as a proximate target for monetary policy during much of th