Reserve Demand Elasticity (RDE)

The Reserve Demand Elasticity (RDE) is a research instrument created by the Federal Reserve Bank of New York that assesses how the federal funds rate reacts to changes in the supply of reserves. It is determined by the slope of the reserve demand curve and offers essential insights into the availability of reserves within the U.S. banking system, aiding in the formulation of monetary policy and the management of the Federal Reserve's balance sheet.

What is Reserve Demand Elasticity?
The Reserve Demand Elasticity (RDE) represents the slope of the reserve demand curve, which gauges how the difference between the federal funds rate and the interest on reserve balances (IORB) varies in response to a 1% increase in total reserves relative to banks’ total assets. This value, expressed in basis points, reveals the sensitivity of the federal funds rate to fluctuations in reserve supply. The RDE provides a real-time overview of the additional money (or “reserves”) available in the U.S. banking system. This slope indicates how much the federal funds rate adjusts in reaction to minor changes in reserve supply.

Abundant Reserves: When reserves are plentiful, the slope of the reserve demand curve is zero, indicating that the federal funds rate remains unchanged despite shifts in reserves.

Ample Reserves: As reserves decrease, the curve takes on a gentle slope, and the federal funds rate begins to respond slightly to changes in reserves.

Scarce Reserves: When reserves are limited, the curve steepens, making the federal funds rate highly responsive to changes in reserve supply.

Monitoring reserve levels is crucial for maintaining stability in money markets and avoiding abrupt rate changes when reserves become too low.

Why does the amount of reserves matter?
This is determined by the reserve demand curve, which illustrates the relationship between the federal funds rate and the available reserves. Here’s how it operates: When reserves are abundant, banks do not compete for them, resulting in minimal changes to the federal funds rate when reserve levels fluctuate. This results in a flat slope for the reserve demand curve. As reserves diminish, banks begin to vie for the limited supply, making the federal funds rate more sensitive to reserve changes, and the curve becomes steeper. If reserves fall too low, even a minor change in supply can lead to significant shifts in the federal funds rate. Maintaining reserves at a sufficient level is essential for ensuring stability. When reserves are plentiful, the Fed does not need to intervene frequently, allowing the banking system to operate smoothly without large interest rate variations.

Development and Publication
The RDE was first introduced in an October 2022 blog post on Liberty Street Economics, the research blog of the New York Fed. An updated version of the methodology and its findings was published in August 2024. Detailed technical aspects of the RDE’s estimation process are documented in earlier Federal Reserve staff reports.

Input Data
The RDE estimates are derived from several key data sources:

• Reserves Data: Aggregate balances held by depository institutions, obtained from Federal Reserve accounting records, normalized by commercial banks’ total assets (weekly data from FRED, linearly interpolated to daily).
• Federal Funds Rate: The daily volume-weighted average rate from federal funds transactions data collected by the New York Fed.
• IORB: The interest on reserve balances, subtracted from the federal funds rate to account for variations in monetary policy stance. For periods before the IORB was introduced, the interest rate on excess reserves (IOER) is used instead.

How to Read RDE Estimates
The RDE estimates indicate the slope of the reserve demand curve, reflecting the sensitivity of the federal funds rate to changes in reserve supply. The slope shows how many basis points the difference between the federal funds and IORB rates changes for a 1% increase in total reserves relative to banks’ assets. Understanding reserve availability involves analyzing how the slope of the reserve demand curve shifts as reserves decrease.

Abundant Reserves
When reserves exceed a certain threshold, banks possess more than enough reserves to satisfy their needs. In this “satiated” state, the demand curve is flat (slope = 0), meaning the federal funds rate does not respond to changes in reserve supply. When reserves are plentiful, banks have all they require, and the federal funds rate remains unchanged, regardless of how much more is added. This is akin to having more water than one can drink—adding more is inconsequential.

Ample Reserves
As reserves fall below the abundant level, we enter the ample reserves region. Here, the demand curve begins to slope gently downward, and the federal funds rate becomes slightly responsive to changes in reserves. The elasticity is negative but small. If reserves start to decrease, the federal funds rate begins to respond slightly. This is similar to feeling a bit thirsty—changes in supply matter, but only to a small extent.

Scarce Reserves
When reserves decline further, we reach the scarce reserves region. The demand curve becomes steep, and even minor changes in reserve supply can lead to significant fluctuations in the federal funds rate. The elasticity is negative and large. When reserves drop too low, even a small change can result in substantial shifts in the federal funds rate. This is comparable to running low on water—every drop suddenly becomes significant.

During 2010–11, the slope was notably negative, indicating scarce reserves. From 2012–17 and mid-2020 onward, the slope approached zero due to abundant reserves, driven by substantial injections during the Global Financial Crisis (GFC) and the COVID-19 pandemic.

Key Findings
The first published estimates of the RDE, based on data as of October 11, 2024, indicated that reserves in the U.S. banking system remain abundant. The results demonstrated that the federal funds rate was not significantly influenced by changes in reserve supply, with the RDE estimates indistinguishable from zero.

Updates
The RDE is updated monthly, typically at 10:00 A.M. Eastern Time on the third Thursday of each month. If the third Thursday coincides with a blackout period for the Federal Open Market Committee (FOMC), the release is postponed to the next business day after the blackout.

Relevance
The RDE enhances the broader understanding of liquidity and monetary policy dynamics, providing stakeholders with vital data for decision-making. Its introduction and subsequent updates underscore the Federal Reserve’s commitment to transparency and data-driven policy implementation.

Additional Measures of Reserve Ampleness
While the RDE is a crucial tool, it is one of several measures utilized by policymakers to evaluate reserve conditions. Other indicators include:

• Money market conditions
• Timing of payments
• Bank liquidity metrics

These metrics, in conjunction with RDE estimates, offer a comprehensive understanding of reserve dynamics and the transition between abundant, ample, and scarce reserves.