SHOULD THERE BE INTRADAY MONEY MARKETS

I. INTRODUCTION The institutional frameworks through which different central banks manage the supply of intraday and overnight reserves to banks share a number of features. Typically, intraday reserves can be obtained directly from the central bank. In contrast, overnight reserves are usually made available to banks through a market. This difference seems puzzling. If one method of providing liquidity works better than the other in one case, should it not work better in both cases? Historically, many central banks provided overnight reserves directly to banks. Only after well-functioning markets for government debt developed did these central banks start to distribute reserves through a market. However, distribution of intraday reserves through a market was never adopted as a common practice. In this article, we consider why this is so. We start by describing the different roles of overnight and intraday reserves and provide important institutional details. In particular, we note that the costs of reserves, both intraday and overnight, are policy variables. Consequently, a market for reserves does not play the traditional role of information aggregation and price discovery. If fact, as we discuss, many demand-management features determined by central bank policy are intended to dampen price variability in the market for reserves. We investigate the possibility of designing a market for intraday reserves and conclude that such a market could be organized in a way similar to the market for overnight reserves. Next, we consider arguments in favor of and against a market for intraday reserves under the assumption that there is an opportunity cost of holding overnight reserves. The monetary policy implementation framework used by most countries relies on such an opportunity cost. We review some academic literature that provides arguments in favor of a market. Freeman (1999) studies an environment in which providing liquidity through a market allows better risk sharing and higher welfare than providing liquidity through a standing facility such as the central bank. Chapman and Martin (2007) study an extension of Freeman's environment in which agents can exert effort to limit their exposure to risk. In that framework, supplying liquidity through a market provides better incentives. We then provide some arguments suggesting that an intraday market may not function well. An intraday market maybe more prone to delays than an overnight market because managing a bank's intraday reserve needs is considerably more difficult than managing its overnight needs. Recent research from the Federal Reserve Bank of Chicago provides some supporting evidence. Also, an intraday market may suffer from the central bank's inability to commit itself to not intervening in the event of a crisis. Indeed, payment delays can affect ancillary systems such as securities settlement, retail payments, or special purpose foreign exchange settlement. This kind of spillover does not necessarily occur in the overnight market. We also argue that the benefits of an intraday market may be small. Finally, we consider how reserves should be provided in an optimal system. Since the analysis in the first part of the article applies if an optimal system requires a positive marginal cost of holding overnight reserves, we focus on the case where the marginal cost of reserves should be zero. Friedman (1969) provides an argument suggesting why such a policy would be optimal. We also discuss the case of New Zealand where a new monetary policy implementation framework provides reserves both intraday and overnight at zero marginal cost. When the opportunity cost of overnight reserves is zero, the distinction between overnight reserves and intraday reserves becomes blurred, as there is no need to economize on overnight reserves. Banks can hold enough reserves overnight to satisfy both their intraday and their overnight needs. …