Open Market Operations: The Market for Bank Reserves

Central Bank Levers

Reserve requirement ratio 10.0%

Interest on excess reserves (IOER) 2.5%

Discount-window rate (ceiling) 3.5%

Open-market operation +0 $B

Reserve Market Readout

Fed funds rate

2.9%

Total reserves

$1,200B

Required reserves

$1,200B

Money multiplier

10.0×

Max deposit expansion

$12,000B

Banks short on reserves

0 / 48

How it works

Banks trade reserve balances held at the central bank in the overnight market. The demand for reserves is downward-sloping: when reserves are scarce relative to what regulation requires, banks bid the rate up toward the discount-window rate (the ceiling — above it, a bank simply borrows from the central bank instead); when reserves are abundant, the rate falls until it is pinned at the IOER floor (below it, no bank would lend for less than it already earns just holding reserves). The model used here:

required R* = ratio × deposit base
demand rate(R) = IOER + (discount − IOER) / (1 + exp[(R − R*) / spread])
supply of reserves R = base + open-market operation (OMO)
equilibrium fed-funds rate = demand rate(R)

The supply of reserves is set directly by the central bank through open-market operations: buying bonds injects reserves (curve shifts right, rate falls toward the floor); selling bonds withdraws them (curve shifts left, rate rises toward the ceiling). This corridor/floor system — not a policy-rate formula — is the actual plumbing every modern central bank (the Fed, ECB, Bank of England) uses to hit its target rate day to day.

Reserve requirement ratio — raises or lowers the required-reserves level R*, sliding the whole demand curve sideways.
IOER / discount rate — set the floor and ceiling of the corridor the funds rate must trade within.
OMO slider / buy / sell buttons — move the vertical supply line left or right along the demand curve, changing where it intersects and so the equilibrium rate.
Money multiplier = 1 / reserve ratio — the theoretical ceiling on how much deposit money the banking system can create per dollar of reserves.

Demand for reserves Reserve supply (OMO) Equilibrium rate Bank reserve balance

→ reserves ($B, 0–3000)
↑ interest rate (0–8%)

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