The Optimal Supply of Central Bank Reserves under Uncertainty

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Staff Reports

The Optimal Supply of Central Bank Reserves under Uncertainty

Number 1077
November 2023

JEL classification: E52, E58, E41, E42

Authors: Gara Afonso, Gabriele La Spada, Thomas M. Mertens, and John C. Williams

This paper provides an analytically tractable theoretical framework to study the optimal supply of central bank reserves when the demand for reserves is uncertain and nonlinear. We fully characterize the optimal supply of central bank reserves and associated market equilibrium. We find that the optimal supply of reserves under uncertainty is greater than that absent uncertainty. With a sufficient degree of uncertainty, it is optimal to supply a level of reserves that is abundant (on the flat portion of the demand curve) absent shocks. The optimal mean spread between the market interest rate and administered rates under uncertainty may be higher or lower than that absent uncertainty. Our model is consistent with the observation that the variability of interest rate spreads is a function of the level of reserves.

Full Article

AUTHOR DISCLOSURE STATEMENT(S)

Gara Afonso
Gara Afonso declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Gabriele La Spada
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Thomas M. Mertens
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

John C. Williams
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.

Suggested Citation:
Afonso, Gara, Gabriele La Spada, Thomas M. Mertens, and John C. Williams. 2023. “The Optimal Supply of Central Bank Reserves under Uncertainty.” Federal Reserve Bank of New York Staff Reports, no. 1077, November. https://doi.org/10.59576/sr.1077

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