The reserve market graph shows how a central bank sets its policy interest rate when banks hold plenty of reserves. In AP Macroeconomics it is the ample reserves model. The vertical axis is the policy rate, such as the federal funds rate. The horizontal axis is the quantity of reserves held by banks. The demand for reserves slopes down at small quantities and then flattens out at a floor. The supply of reserves is a vertical line set by the central bank.
The key idea is that, in an ample reserves system, the supply line crosses demand on the flat part. Small changes in the quantity of reserves then do not move the rate. Instead the central bank moves the rate by changing the interest it pays on reserve balances, which shifts the flat part of demand up or down. Educational only, not investment advice. The graph below is a teaching sketch with no data.
How to draw the reserve market graph
- Label the vertical axis the policy rate (in the United States, the federal funds rate) and the horizontal axis the quantity of reserves.
- Draw demand for reserves sloping down on the left, then flat to the right. Mark the flat section at the interest on reserve balances rate, often written IORB.
- Draw a vertical supply of reserves that crosses demand on the flat section. That crossing is the equilibrium policy rate.
Why does demand go flat? A bank will not lend reserves overnight to another bank for less than it can earn by leaving them at the central bank. So the rate the central bank pays on reserves acts as a floor, and once reserves are plentiful the market rate sits close to it.
Ample reserves versus limited reserves
| Feature | Ample reserves | Limited reserves |
|---|---|---|
| Where supply meets demand | Flat section of demand | Downward sloping section of demand |
| Main tool for the policy rate | Administered rates such as IORB | Open market operations that change reserves |
| Effect of a small open market purchase | Little or no change in the rate | Rate falls |
| Where it appears in AP Macro | Unit 4, the current Federal Reserve framework | Unit 4, often taught alongside the money multiplier |
The Federal Reserve announced in January 2019 that it intends to keep operating with ample reserves, steering the federal funds rate mainly through administered rates such as interest on reserve balances. That is why the College Board course treats ample reserves as the main model for current US monetary policy. The Bank of England also pays its policy rate, Bank Rate, on reserve balances, so the same floor idea helps UK readers.
Which tool moves the rate
To tighten in an ample reserves system, the central bank raises IORB. The flat part of demand shifts up and the policy rate rises with it. To loosen, it lowers IORB and the flat part shifts down. Shifting the vertical supply line left or right by a modest amount leaves the rate unchanged, because the crossing stays on the flat section. The Fed also uses an overnight reverse repurchase facility as a further floor for money market rates, but AP questions focus on IORB.
In a limited reserves system the old textbook story applies. An open market purchase adds reserves, supply shifts right along the sloping part of demand, and the rate falls. The money market and loanable funds explainer draws that story on the money market graph.
From the policy rate to aggregate demand
A higher policy rate feeds through to other interest rates. Borrowing for investment and big purchases falls, so aggregate demand shifts left, real output falls in the short run, and the price level falls compared with where it would have been. A lower rate does the reverse. Practise that chain on the aggregate demand and aggregate supply explainer, and compare the policy rate with inflation on the real interest rates page.
Common AP exam mistakes
- Shifting supply of reserves to change the rate in an ample reserves graph. Move the IORB level instead.
- Drawing supply crossing demand on the sloping section when the question says ample reserves.
- Labelling the horizontal axis money supply. This graph is about reserves, not the whole money stock. See M1 and M2.
- Forgetting the chain to investment and aggregate demand when a question asks about output.
Short definitions sit in the glossary under policy rate and nominal. The full unit list is on the AP Macro review hub.
Sources
- Federal Reserve, Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization, 30 January 2019
- Federal Reserve, Interest on Reserve Balances
- Bank of England, Market Operations Guide
- College Board, AP Macroeconomics course page
Common questions
What is the ample reserves graph in AP Macro?
It is the reserve market graph used to show current Federal Reserve policy. The policy rate is on the vertical axis and the quantity of reserves on the horizontal axis. Demand for reserves slopes down then turns flat at the interest on reserve balances rate, and a vertical supply of reserves crosses demand on that flat section.
How does the Fed raise interest rates with ample reserves?
It raises the interest on reserve balances rate. That lifts the flat section of reserve demand, and the federal funds rate rises with it. Changing the quantity of reserves by a modest amount would not move the rate, because supply still crosses the flat section.
Do open market operations still matter?
Yes, but in an ample reserves system they mainly keep reserves plentiful rather than set the daily rate. In a limited reserves system, an open market purchase shifts reserve supply right along the sloping part of demand and lowers the rate.
What is the difference between the reserve market and the money market?
The reserve market is about bank reserves and the policy rate. The money market is about the whole stock of money and the nominal interest rate. AP questions may use either, so read the axis labels the question gives.