## Modeling the Reserve Demand to Facilitate Central Bank Operations

_IMF Working Papers, September 1, 2023_

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## Bibliographic details
- Authors: Zhuohui Chen, Nikolaos Kourentzes, Romain M Veyrune
- Published: September 1, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400253348.001

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### Overview
- Title: Modeling the Reserve Demand to Facilitate Central Bank Operations
- Authors: Zhuohui Chen, Nikolaos Kourentzes, Romain M Veyrune
- Date: September 1, 2023
- Type: IMF Working Papers
- Summary points:
  - The work offers a modeling methodology for estimating banks’ demand for liquidity (“reserves”) at the central bank.
  - The demand for reserves is influenced by various macro and market structure variables.
  - The model helps central banks identify “stable points” on the demand for reserves—levels of reserves for which short-term interest rate volatility is minimal.
  - Both parametric and non-parametric approaches are provided, with a focus on capturing modeling uncertainty and facilitating scenario analysis.
  - The methodology is evaluated using data from the Eurosystem and the US Federal Reserve System.

### Methodology
- Modeling approaches provided:
  - Parametric expressions.
  - Non-parametric approaches.
- Modeling objectives and features:
  - Capture the influence of macro and market structure variables on reserve demand.
  - Explicit focus on modeling uncertainty to facilitate scenario analysis.
  - Provide a method to test forecasting performance across approaches and combinations of exogenous regressors.

### Key findings
- Forecasting and model-performance findings:
  - Simpler parametric expressions provide on balance better performances.
  - Adding variables to both parametric and non-parametric models provides better explanations and predictions.
- Operational insight:
  - Identification of “stable points” where short-term interest rate volatility is minimal aids central bank operations and implementation of monetary policy.

### Evaluation and data
- Empirical evaluation:
  - Proposed methodology evaluated using data from the Euro system and the US Federal Reserve System.
- Performance testing:
  - A method is proposed to test the forecasting performances of different approaches and exogenous regressor combinations.

### Policy implications and applications
- Use for central banks:
  - Inform central bank operations by estimating reserve demand and locating stability points for short-term interest rates.
  - Facilitate scenario analysis by explicitly modeling uncertainty.
- Practical recommendation:
  - Consider simpler parametric specifications where forecasting performance is a priority, while augmenting models with additional relevant variables to improve explanation and prediction.

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_Source: https://www.imf.org/en/publications/wp/issues/2023/09/01/modeling-the-reserve-demand-to-facilitate-central-bank-operations-538754_