Chapter 2: Stylized facts and bank liquidity preference
Commercial bank liquidity preference can be seen as the demand for reserves. The stylized facts of banks’ demand for liquidity are shown in Figures 2.1 to 2.21 for 42 economies. This chapter will also discuss the reserve money programme (RMP), which is a system used by the central bank to manage the supply of excess reserves. Supply of reserves change depending on the degree sterilization (or compensation) and other exogenous shocks buffeting bank liquidity. The RMP is a liquidity management tool used by many central bank research departments around the world. Economists in developing countries often receive training at the IMF Institute in Washington DC on how to carry out a reserve money exercise. The training involves techniques necessary for forecasting reserves of commercial banks. Moreover, the framework of liquidity management should be taken in the context of oligopolistic determination of interest rates by commercial banks. Barring the exogenous liquidity supply shocks, it would be easier to change bank reserves than have banks adjust rates according to a Taylor-type interest rate rule. This type of interest rate reaction function or rule may simply not be possible because the pass-through to deposit and loan interest rates is negligible, and because of the limited development of secondary money and capital markets. Immediately below we will look at the demand side or evidence of bank liquidity preference. Section 2.3 presents a discussion on financial programming and its practical cousin, the RMP.
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