Research Scan: Kansas City Fed Finds Reserve Levels Adequate

Federal Reserve Board officials may be overreacting to the precipitous decline in reserves kept at the central bank, according to a forthcoming study.

Economists at the Federal Reserve Bank of Kansas City found that the central bank can conduct monetary policy successfully with even low levels of reserves.

Reserves have fallen by more than one-third, to $16.1 billion, in the past two years as banks increasingly transfer, or sweep, deposits into money market funds from checking and savings accounts. This reduces the amount of cash a bank must hold at the Fed because money market funds are exempt from reserve requirements.

The paper, to be published shortly in the Kansas City Fed's Economic Review, concludes that banks always will keep some reserves with the Fed, even if sweep accounts reduce their balances. The reason: Institutions also use reserve accounts to settle check-clearing debts on a daily basis.

Although the level of reserves will be lower, the Fed will still be able to manipulate the market to force banks to borrow money at the interest rate set by the Federal Open Market Committee.

"As long as there is a demand for settlement balances, central banks can influence short-term interest rates by altering the supply of these balances," according to Kansas City Fed economists Gordon H. Sellon and Stuart E. Weiner.

While short-term interest rates could be less stable, they said, the Fed could counter the turbulence by imposing a ceiling for overnight interest rates.

For a copy of "Monetary Policy Without Reserve Requirements," call 816- 881-2000.

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Did the banking agencies exacerbate the thrift crisis by overestimating the amount of regulatory goodwill held by ailing institutions? That's the novel conclusion of University of Virginia professor Anthony H. Catanach Jr., who says in a just-completed study that examiners should not have forced thrifts to write off tax credits inherited during the mergers. Investors and creditors of the failed thrifts, who are suing the government for illegally eliminating goodwill, are entitled to recoup the value of these tax credits, he said.

For a copy of "The Policy Implications of Legislating Accounting Changes," call 804-924-3257.

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The government should not expect savings rates to climb if it adopts new tax incentives, according to Neil H. Buchanan, a resident scholar at the Jerome Levy Economics Institute at Bard College.

Consumers are more interested in maintaining their spending habits than in boosting savings and will ignore even attractive investment opportunities, he said. Mr. Buchanan also questioned the public policy rationale for boosting savings rates, saying there is no evidence that increased consumer savings would boost economic production.

For a copy of Paper No. 177, call the Levy Institute at 914-758-7700.

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Checks may not be as overused as some policy experts contend, according to a study by Kirsten E. Wells, senior analyst at the Federal Reserve Board.

Policy experts have concluded that consumers should be writing fewer checks because electronic systems are less expensive. But Ms. Wells said those studies underestimated the cost of setting up electronic payment systems.

For a copy of "Are Checks Overused?" call the Federal Reserve Bank of Minneapolis at 612-340-2345.

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