Finance and Economics Discussion Series (FEDS)

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August 2019

A Simple Model of Voluntary Reserve Targets with Tolerance Bands

Garth Baughman and Francesca Carapella

Abstract:

This note presents a simplifed version of the model of voluntary reserve targets (VRT) developed in Baughman and Carapella (forthcoming), with a Walrasian interbank market. First, the model makes transparent the role of target setting in controlling the market rate. Second, the simplicity of the model allows for an analysis of the interaction between VRT and tolerance bands, which are a common tool for controlling rate variability. We find that the persistent overshooting of interbank rates observed during the Bank of England's experiment with VRT may derive from the interaction between target setting and tolerance bands, a new explanation relative to the literature. We also suggest a simple remedy.

Accessible materials (.zip)

Keywords: Monetary Policy Implementation, Tolerance Bands, Voluntary Reserve Tartgets

DOI: https://doi.org/10.17016/FEDS.2019.060

PDF: Full Paper

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Last Update: January 09, 2020