Day-To-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate

We propose a model of the interbank money market with an explicit role for central bank intervention and periodic reserve requirements, and study the interaction of profit-maximizing banks with a central bank targeting interest rates at high frequency. The model yields predictions on biweekly patterns of the federal funds rate’s volatility and on its response to changes in target rates and in intervention procedures, such as those implemented by the Federal Reserve in 1994. Theoretical results are consistent with empirical patterns of interest rate volatility in the U.S. market for federal funds.Interest rates;equation, martingale, monetary policy, predictions, reserve requirements, empirical model, samples, probability, treasury securities, liquidity management, money market, money markets, standard deviation, interest rate targeting, outlier, statistics, prediction, cumulative distribution function, monetary economics, central bank, robust statistics, monetary fund, monetary theory, probability distribution, normal distribution, normal distributions, optimization, inflation, econometrics, standard errors, random variable, monetary considerations, perturbation, stochastic model, standard deviations, demand for money, random variables, money demand, monte carlo simulation, outliers