Ample reserves dynamics risk balance sheet instability

A Philadelphia Fed working paper explores how the implementation of monetary policy can lead to unstable central bank balance sheet dynamics. The research by Roc Armenter highlights a feedback loop between liquid deposits and the ample level of reserves.

The feedback loop of reserves and deposits

The paper defines "ample reserves" as the level at which the effective federal funds rate (EFFR) equals the interest on reserves (IOR), or a preset spread between them.

This definition, compatible with the FOMC's 2019 statement, underpins monetary policy implementation.

However, the research by Roc Armenter reveals that this "ample" level is not static.

If liquid deposits increase the demand for reserves, as argued by Lopez-Salido and Vissing-Jorgensen (2025), then the ample level itself becomes a function of these deposits.

A critical feedback loop arises if the supply of reserves further encourages deposit creation, a phenomenon documented by Acharya et al. (2024).

This coupling can significantly amplify the intrinsic persistence of deposits, potentially leading to "explosive dynamics" where ample reserves grow without bound, taking the Fed's balance sheet along for the ride.

An off-the-shelf calibration exercise finds that even modest amounts of intrinsic deposit persistence could trigger such instability, driven by a very high elasticity of ample reserves to deposits.

The study emphasizes that without a clear path to identify underlying trends, the intrinsic persistence of deposits remains a "known unknown" in the stability condition.

Calibrated risks, attenuated solutions

The model, which couples the main specifications from Lopez-Salido and Vissing-Jorgensen (2025) and Acharya et al. (2024), formalizes these complex dynamics.

It views the supply of reserves, ample reserves, and deposits as log-deviations from unspecified trends, sufficient to establish local properties of the system.

Simulations under stable roots show that reserves first reach ample levels earlier and at a higher level than expected if the role of deposits is not accounted for.

This means ample reserves fully normalize only as deposits do.

Fortunately, the Open Market Desk can simply attenuate the response of ample reserves to deposits.

This strategy, while allowing for some modest policy rate deviations, drastically reduces the persistence of the system and hence the risk of explosive dynamics.

Attenuation plots a lower path for the Fed's balance sheet, with a longer quantitative tightening (QT) phase and lower deposits, proving to be a robust approach for policymakers.

A timely warning for balance sheet management

This paper offers a crucial theoretical framework for understanding the complex interplay between central bank reserves and commercial bank deposits.

While not providing empirical evidence for the underlying claims, its model highlights a significant, often overlooked, risk to balance sheet stability in an ample reserves regime.

Policymakers should heed the warning regarding potential explosive dynamics and consider the proposed attenuation strategies to safeguard financial stability and ensure predictable monetary policy implementation.