The Lagged Reserve Requirement and the Short-term Interest Rate

Private banks are required to hold as the legal reserve a fixed portion of the deposit that they accepted from the private sector during a given month. This reserve must be held as the sum of the daily deposit at the central bank during the following month. This is called the lagged reserve requirement. The officials of the Bank of Japan insist that they can control the shorトterm interest rate by using this requirement, especially by adjusting the pace at which banks accumulate the reserve. There are some studies which aim to make clear this mechanism of controlling the short-term interest rate, but they do not seem to have succeeded. The aim of this paper is to examine whether the central bank can control the short-term interest rate by adjusting the speed at which banks accumulate the required reserve under the lagged reserve requirement system. We assume that the total amount of reserve during the two consecutive periods must be equal to the required one. The model can be constructed as a game played between the central bank and a private bank. The central bank supplies the reserve while a private bank demands that. In the first period, the central bank sets the target value of the interest rate of which a private bank is not informed, and decides how much reserve she supplies and declares it. After gaining that information, a private bank decides how much reserve she demands. Then the supply and demand of reserve determine the interest rate in the first period. In the second period, as a private bank must hold the remaining part of the reserve no matter how much it costs, she demands it at the rate that the central bank decides whenever she needs, so the interest rate is fixed at thatlevel. The results are the following. The central bank can control the short-term interest rate by adjusting the speed at which a private bank accumulates the required reserve during the period, but she can succeed only when the target value of the interest rate is within some range. The central bank cannot set the interest rate too low or high