David Eagle

Federal-funds-rate volatility and the reserve-maintenance period

Abstract The day-to-day changes in the federal funds rate affects all banks, in particular those banks who execute their single federal funds transaction through larger correspondent banks. This papers stochastic equilibrium model discusses how a major determinant of that behavior—the banks reserve-maintenance period—molds the interday pattern of federal-funds-rate volatility. In particular, the model explains why the volatility of the federal funds rate increases from the beginning to the end of that period. While Spindt and Hoffmeister (1988) tried to explain that increases in terms of transaction-cost avoidance, this papers model demonstrates that rational expectations alone will generate this effect. It also shows that lengthening the reserve-maintenance period increases federal-funds rate volatility on the last day of the period.

Quasi-real bonds: inflation-indexing that retains the government's hedge against aggregate-supply shocks

Inflation-indexed bonds, such as the UKs indexed-linked gilts and Canadas real return bonds, are hailed by economists for reducing inflation risk to both borrowers and lenders. However, we find that fixed-rate bonds have an advantage over inflation-indexed bonds by providing borrowers with a hedge against aggregate-supply shocks. National governments would benefit from this in the event of a major catastrophe that substantially reduces aggregate supply. To retain this hedge and still provide indexing for aggregate-demand-caused inflation, we propose a financial innovation called quasi-real bonds which are indexed to nominal GDP growth.