Excess reserves and the implementation of monetary policy of the ECB

This paper explains how excess reserves are relevant for today's central banks in the implementation of monetary policy, focusing on the specific case of the policy framework of the European Central Bank (ECB). In particular, this paper studies the impact that changes to the operational framework for monetary policy implementation have on the level and volatility of excess reserves. A transaction cost model that replicates the intra-reserve maintenance period pattern of excess reserves is developed. Simulation results presented show that both the level and volatility of excess reserves may increase considerably under some changes to the operational framework. This is important as errors in forecasting excess reserves weaken the central bank's control of short-term interest rates.