The Reserve Demand Elasticity (RDE) is a research tool developed by the Federal Reserve Bank of New York that measures how the federal funds rate responds to shifts in the supply of reserves.
It is calculated as the slope of the reserve demand curve and provides critical insights into reserve ampleness in the U.S. banking system, helping to inform monetary policy and Federal Reserve balance sheet management.
What is Reserve Demand Elasticity?
The Reserve Demand Elasticity (RDE) is the slope of the reserve demand curve, which measures how the spread between the federal funds rate and the interest on reserve balances (IORB) changes in response to a 1% increase in aggregate reserves relative to banks’ total assets.
This value, expressed in basis points, provides insights into how sensitive the federal funds rate is to changes in reserve supply.
The RDE gives a real-time snapshot of how much extra money (or “reserves”) is available in the U.S. banking system.
This slope determines how much the federal funds rate changes in response to small shifts in reserve supply.
- Abundant Reserves: When reserves are abundant, the slope of the reserve demand curve is zero, meaning the federal funds rate does not change in response to reserve shifts.
- Ample Reserves: As reserves decline, the curve becomes gently sloped, and the federal funds rate responds slightly to reserve changes.
- Scarce Reserves: When reserves are scarce, the curve steepens, and the federal funds rate becomes highly sensitive to reserve supply changes.
Tracking reserve levels is important because it helps ensure stability in money markets and prevents sudden rate changes when reserves get too low.
Why does the amount of reserves matter?
This depends on something called the reserve demand curve, which shows the relationship between the federal funds rate and the amount of reserves available. Here’s how it works:
- When reserves are plentiful, banks don’t need to fight over them, so the federal funds rate barely changes when reserve levels shift. This means the slope of the reserve demand curve is flat.
- As reserves shrink, banks start competing for the limited supply. The federal funds rate becomes more sensitive to changes in reserves, and the curve becomes steeper.
- If reserves get too low, even a small change in supply can cause a big swing in the federal funds rate.
Keeping reserves at a high enough level ensures stability.
When reserves are ample, the Fed doesn’t need to constantly intervene, and the banking system functions smoothly without big interest rate fluctuations.
Development and Publication
The RDE was first introduced in an October 2022 blog post on Liberty Street Economics, the research blog of the New York Fed.
An updated version of the methodology and its findings was published in August 2024.
Detailed technical aspects of the RDE’s estimation process are documented in earlier Federal Reserve staff reports.
Input Data
The RDE estimates are derived from several key data sources:
- Reserves Data: Aggregate balances held by depository institutions, obtained from Federal Reserve accounting records, normalized by commercial banks’ total assets (weekly data from FRED, linearly interpolated to daily).
- Federal Funds Rate: The daily volume-weighted average rate from federal funds transactions data collected by the New York Fed.
- IORB: The interest on reserve balances, subtracted from the federal funds rate to control for monetary policy stance variations.
For periods before the IORB was introduced, the interest rate on excess reserves (IOER) is used instead.
How to Read RDE Estimates
The RDE estimates show the slope of the reserve demand curve, reflecting how sensitive the federal funds rate is to reserve supply changes.
The slope indicates by how many basis points the spread between the federal funds and IORB rates changes for a 1% increase in aggregate reserves relative to banks’ assets.
Understanding reserve ampleness involves examining how the slope of the reserve demand curve changes as reserves decline.
Abundant Reserves
When reserves are above a certain level, banks have more than enough reserves to meet their needs.
In this “satiated” state, the demand curve is flat (slope = 0), meaning the federal funds rate does not react to changes in the supply of reserves.
When there are plenty of reserves, banks have all they need, and the federal funds rate doesn’t change, no matter how much more is added. This is like having more water than you can drink – adding more won’t matter.
Ample Reserves
As reserves drop below the abundant level, we enter the ample reserves region.
Here, the demand curve starts to slope gently downward, and the federal funds rate becomes slightly responsive to reserve changes. The elasticity is negative but small.
If reserves start to drop a bit, the federal funds rate begins to respond slightly. This is like starting to feel a bit thirsty – changes in supply matter, but only a little.
Scarce Reserves
When reserves decline even further, we reach the scarce reserves region.
The demand curve becomes steep, and even small changes in reserve supply can cause significant fluctuations in the federal funds rate. The elasticity is negative and large.
When reserves drop too much, even a small change can cause big shifts in the federal funds rate. This is like running low on water – every drop suddenly counts.
During 2010–11, the slope was significantly negative, reflecting scarce reserves. From 2012–17 and mid-2020 onward, the slope approached zero due to abundant reserves, driven by large injections during the Global Financial Crisis (GFC) and the COVID-19 pandemic.
Key Findings
The first published estimates of the RDE, based on data as of October 11, 2024, indicated that reserves in the U.S. banking system remain abundant.
The results showed that the federal funds rate was not significantly affected by changes in reserve supply, with the RDE estimates indistinguishable from zero.
Updates
The RDE is updated monthly, typically at 10:00 A.M. Eastern Time on the third Thursday of each month.
If the third Thursday coincides with a blackout period for the Federal Open Market Committee (FOMC), the release is postponed to the next business day after the blackout.
Relevance
The RDE contributes to the broader understanding of liquidity and monetary policy dynamics, providing stakeholders with critical data for decision-making.
Its introduction and subsequent updates highlight the Federal Reserve’s commitment to transparency and data-driven policy implementation.
Additional Measures of Reserve Ampleness
While the RDE is a critical tool, it is one of several measures used by policymakers to assess reserve conditions. Other indicators include:
- Money market conditions
- Timing of payments
- Bank liquidity metrics
These metrics, combined with RDE estimates, provide a comprehensive understanding of reserve dynamics and the transition between abundant, ample, and scarce reserves.