Regime Switching in the Dynamic Relationship Between the Federal Funds Rate and Innovations in Nonborrowed Reserves.

This paper outlines the vibrant relationship between changes in the funds rate and nonborrowed reserves. The author examines a reduced form framework that allows the relationship to have two distinct patterns over time. On average, CPI inflation has been significantly higher in the regime characterized by large and volatile changes in funds rate. Modernization of money growth is associated with a strong anticipated inflation effect in this high inflation regime, and a moderate liquidity effect in the low inflation regime. Identical money innovation generates a much bigger increase in the interest rate during a transition period from the low to high inflation regime. This working paper can be found at the US Federal Reserve Board's International Finance Discussion Papers. You can access this by going to <http://www.federalreserve.gov/pubs/workingpapers.htm>