Abstract
Retail sweep accounts have reduced required bank reserve balances by more than 70% since 1995, raising concerns in some quarters about increased volatility of interest rates and reduced monetary policy effectiveness. We develop a model of bank reserve management and daily payment flows that indicates that the effect of lower reserve balances on funds rate volatility is theoretically ambiguous. We empirically test the relationships among reserve balances, federal funds-rate volatility, and the variation in short-term money market rates. Our conclusion is that reductions in reserve balances have not impinged on the ability of the Federal Reserve to conduct monetary policy in the manner that it has in recent years.
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