An economic analysis of the Federal funds market

From an historical perspective, the Federal funds market has evolved from a receptacle of idle reserve balances into a leading short-term money market. Analogously, the improved supervision of reserve positions has enabled banks to include Federal funds as a useful instrument in their liability debt management policies; formerly, these borrowed funds were used primarily as a supplementary reserve adjustment measure. Consequently, Federal funds perform a dual role in an individual bank's decision function--as a potential asset in its portfolio and as a liability in its debt management policy. In spite of the historical growth of the Federal funds market, there has been no concomitant growth in the contemporary literature related to this financial instrument. Much has been written about the entire Federal funds market and its effects on monetary policy, but relatively few of these research efforts have considered the micro-foundations of an individual bank's participation in this market. Numerous studies have developed theoretical models to help explain a financial institution's behavior toward other instruments. However, little attempt has been made to apply these techniques to Federal funds. The purpose of this treatise is to construct and empirically test a model of an individual bank's behavior in the Federal funds market. ..