Thanks to a comment on the last post, I found The Fed working newspaper explaining Fed's thinking most overnight contrary repurchases, Overnight RRP Operations equally a Monetary Policy Tool: Some Design Considerations by Josh Frost, Lorie Logan, Antoine Martin, Patrick McCabe, Fabio Natalucci, in addition to Julie Remache.
(I should conduct keep found it on my own, equally it's the tiptop newspaper on the Fed's working newspaper list.) Cecchetti in addition to Shoenholtz also comment here
My master copy query was simply what "financial stability" concerns the Fed has amongst RRP, in addition to this newspaper explains.
Background in addition to recap
Influenza A virus subtype H5N1 quick recap in addition to background, informed yesteryear comments in addition to some helpful emails (thanks): Banks conduct keep most $3 Trillion reserves, corresponding to $3 Trillion of securities that the Fed bought. When it's fourth dimension to enhance rates, the Fed plans to simply pay higher involvement on these reserves. The Fed is worried banks volition simply say "thank you" in addition to non enhance deposit rates. So the Fed is effectively offering coin marketplace seat funds (etc) the chance also to invest inwards interest-paying reserves. If banks don't enhance deposit rates, funds will, in addition to attempt to attract banking concern deposits. The funds volition also attempt to sell Treasuries, raising those rates.
In a contrary repo, the lender gives the Fed cash (reserves), in addition to the Fed gives the lender securities equally collateral. Why contrary repos? Influenza A virus subtype H5N1 correspondent explains, "The Federal Reserve Act allows the Fed to conduct keep deposits solely from depository institutions in addition to the States authorities (including GSEs) in addition to to pay involvement solely to depository institutions. It would conduct keep an human activity of Congress to allow the Fed to pay involvement on accounts held yesteryear MMMFs. However, the police force allows the Fed to engage inwards opened upwardly marketplace seat transactions inwards States authorities securities ... amongst simply most anyone."
Key points: The Fed is soundless controlling the size of the residuum sheet. If the Fed actually wanted an ironclad (rocket-powered?) liftoff tool, it would say "Bring us your Treasuries. We volition give you lot interest-paying reserves inwards return." Then, if bond markets give the Fed $1 trillion of treasuries, the Fed creates an extra $1 trillion of reserves. (Yes, increasing the residuum canvass is a tightening move. Welcome to our novel world.) If you lot wish to peg a toll (interest rate), announcing "do what it takes" quantities is a adept idea. The Fed is non planning to do this. (Yet!)
The Fed is also contemplating caps on the size of the facility, rather than "full allotment." Full allocation is apparently to a greater extent than powerful. One wonders what happens if the Fed says 1%, Deposit rates become upwardly 0.2%, treasury rates become upwardly 0.2%, in addition to the Fed hits the cap.
Important point: every dollar of novel reverse-repo "deposits" at the Fed must come upwardly from i dollar less banking concern reserves at the Fed. The coin marketplace seat fund desiring to do an RRP must sell treasuries (or something else), instruct some reserves, give those reserves to the Fed. The solely house those reserves tin john come upwardly from is a bank. So, on net, banking concern reserves become downwards $1, in addition to coin fund holdings of reserves become upwardly yesteryear $1. It's a shift from left steal to correct pocket.
Moreover, the Fed is offering nil that a coin marketplace seat fund backed yesteryear short-term Treasuries in addition to means securities tin john offer. The Fed is nothing but a coin marketplace seat fund backed yesteryear Treasury in addition to means securities!
With this background, I bring out it hard to sympathise how the ON RRP tin john conduct keep whatsoever "financial stability" problems. How tin john opening upwardly a coin marketplace seat fund invested inwards Treasuries in addition to Agency securities live dangerous?
The paper
The summary:
The newspaper starts amongst dot 3)
Now, the cardinal dot 2) fiscal stability inwards a run.
It is also quite a curious mental attitude that the Fed should bound the provision of money-like assets inwards a run, in addition to insist that prices plummet instead. By in addition to large the Fed does just the opposite. The Fed flooded the marketplace seat amongst coin inwards the crisis, equally it is supposed to do in addition to volition do again. (As the newspaper explains nicely).
If the Fed does non purchase assets, the private sector cannot inwards total sell them.
Mistaking private flows for aggregate flows is i of the most basic (and easy) errors inwards thinking most fiscal markets. Daily, intelligence outlets enjoin us that "investors fled from stocks to bonds" or vice versa. No they didn't. For every seller at that spot is a buyer.
There is a flake of feel inwards this:
But... coin marketplace seat funds that invest inwards curt term treasuries rest available. Treasuries themselves are available (we're talking large institutional investors hither non mom in addition to pop.)
Later,
We're going some inwards circles, so I'll halt here.
I heard i real adept declaration at tiffin today: If at that spot is a large RRP facility, in addition to if many large coin marketplace seat funds are one-half invested in, say, Greek banking concern debt in addition to one-half invested inwards RRP, so the Fed may experience that these funds are "too large to fail" because they're asset so much reserves, in addition to experience the request to bail them out of their Greek debts. That, however, is a cynical colleague at tiffin in addition to non inwards this paper.
In response to these concerns, the Fed is planning to hobble the effort: I am reminded of the wisdom shown inwards our unusual policy since the Johnson Administration, of announcing troop withdrawals in addition to all the things nosotros volition non do, to allay political fears.
Last thoughts
On a long airplane flying yesterday I watched Janet Yellen's testimony inwards the Senate Banking Committee. I was impressed yesteryear her masterful treatment of the questions. And I gained a novel appreciation of the political constraints the Fed is operating nether here. Paying large involvement on reserves in addition to opening that upwardly to Wall Street is going to live tough, no thing how groovy equally a thing of economics. I sympathise the strong wish to label monetary policy "normal."
Here I recall the Fed dug itself inwards a flake of a hole. By trumpeting how groovy QE was, in addition to how much stimulation it did, the Fed instantly would bring out it real hard to say "we've been reading Cochrane (and many others) in addition to the huge residuum canvass is doing nil at all stimulative in addition to is kinda dainty for fiscal stability. So we'll simply instruct out it all outstanding in addition to pay IOR, in addition to telephone telephone that 'normal'."
Another colleague's bright tiffin insight. The Fed may conduct keep deliberately dug itself inwards a hole. By buying lots of long-term bonds, the Fed volition conduct keep large grade to marketplace seat losses if involvement rates rise, in addition to halt remitting coin to the Treasury. This is a precommitment non to enhance rates. So, a adept response to "how did QE 'work'" is non simply yesteryear implicitly promising to expire on rates depression for a long time, but yesteryear making it real hard to enhance rates!
(I should conduct keep found it on my own, equally it's the tiptop newspaper on the Fed's working newspaper list.) Cecchetti in addition to Shoenholtz also comment here
My master copy query was simply what "financial stability" concerns the Fed has amongst RRP, in addition to this newspaper explains.
Background in addition to recap
Influenza A virus subtype H5N1 quick recap in addition to background, informed yesteryear comments in addition to some helpful emails (thanks): Banks conduct keep most $3 Trillion reserves, corresponding to $3 Trillion of securities that the Fed bought. When it's fourth dimension to enhance rates, the Fed plans to simply pay higher involvement on these reserves. The Fed is worried banks volition simply say "thank you" in addition to non enhance deposit rates. So the Fed is effectively offering coin marketplace seat funds (etc) the chance also to invest inwards interest-paying reserves. If banks don't enhance deposit rates, funds will, in addition to attempt to attract banking concern deposits. The funds volition also attempt to sell Treasuries, raising those rates.
In a contrary repo, the lender gives the Fed cash (reserves), in addition to the Fed gives the lender securities equally collateral. Why contrary repos? Influenza A virus subtype H5N1 correspondent explains, "The Federal Reserve Act allows the Fed to conduct keep deposits solely from depository institutions in addition to the States authorities (including GSEs) in addition to to pay involvement solely to depository institutions. It would conduct keep an human activity of Congress to allow the Fed to pay involvement on accounts held yesteryear MMMFs. However, the police force allows the Fed to engage inwards opened upwardly marketplace seat transactions inwards States authorities securities ... amongst simply most anyone."
Key points: The Fed is soundless controlling the size of the residuum sheet. If the Fed actually wanted an ironclad (rocket-powered?) liftoff tool, it would say "Bring us your Treasuries. We volition give you lot interest-paying reserves inwards return." Then, if bond markets give the Fed $1 trillion of treasuries, the Fed creates an extra $1 trillion of reserves. (Yes, increasing the residuum canvass is a tightening move. Welcome to our novel world.) If you lot wish to peg a toll (interest rate), announcing "do what it takes" quantities is a adept idea. The Fed is non planning to do this. (Yet!)
The Fed is also contemplating caps on the size of the facility, rather than "full allotment." Full allocation is apparently to a greater extent than powerful. One wonders what happens if the Fed says 1%, Deposit rates become upwardly 0.2%, treasury rates become upwardly 0.2%, in addition to the Fed hits the cap.
Important point: every dollar of novel reverse-repo "deposits" at the Fed must come upwardly from i dollar less banking concern reserves at the Fed. The coin marketplace seat fund desiring to do an RRP must sell treasuries (or something else), instruct some reserves, give those reserves to the Fed. The solely house those reserves tin john come upwardly from is a bank. So, on net, banking concern reserves become downwards $1, in addition to coin fund holdings of reserves become upwardly yesteryear $1. It's a shift from left steal to correct pocket.
Moreover, the Fed is offering nil that a coin marketplace seat fund backed yesteryear short-term Treasuries in addition to means securities tin john offer. The Fed is nothing but a coin marketplace seat fund backed yesteryear Treasury in addition to means securities!
With this background, I bring out it hard to sympathise how the ON RRP tin john conduct keep whatsoever "financial stability" problems. How tin john opening upwardly a coin marketplace seat fund invested inwards Treasuries in addition to Agency securities live dangerous?
The paper
The summary:
... an ON RRP facility could conduct keep repercussions for fiscal stability. These mightiness include beneficial effects arising from the increased availability of safe, short-term assets to investors amongst cash administration needs.Yes! Translation 1) Interest-paying narrow banking is groovy for stability.
However, at that spot may live adverse effects stemming from the possibility that such a facility—particularly if it offers total allotment—could allow a real large, unexpected increment inwards ON RRP take-up that mightiness enable disruptive flight-to-quality flows during periods of fiscal stress. In addition, real large usage of an ON RRP facility, peculiarly if it were permanently inwards place, would expand the Federal Reserve’s footprint inwards short-term funding markets in addition to could alteration the construction in addition to performance of those markets inwards ways that may live hard to anticipate. Indeed, FOMC policymakers conduct keep expressed concerns most a sustained expansion of the Federal Reserve’s role inwards fiscal intermediation in addition to the risk that ON RRPs mightiness magnify strains inwards short-term funding markets during periods of fiscal stress (FOMC 2014a,b).2) But perhaps it would facilitate a flying to character or run. 3) Banks won't similar it if nosotros conduct keep over their business. 4) Our bosses conduct keep already opined on this question, so don't aspect us to conduct keep a strong stand.
The newspaper starts amongst dot 3)
3.1. Potential effects of a real large ON RRP facility on fiscal intermediation
By offering a novel shape of overnight risk-free investment, an ON RRP facility could attract cash from investors who otherwise mightiness provide funding for private institutions in addition to firms. That is, the facility could expand the Federal Reserve’s role inwards fiscal markets yesteryear offering investors a novel tool to deal liquidity in addition to hence could crowd out some private financing...I recall this is simply wrong, in addition to it reflects a classic confusion of the private in addition to the aggregate. As above, the Fed holds the same number of treasuries. For every dollar of reserves held yesteryear coin marketplace seat funds nether RRP, banks must agree i dollar less.
Importantly, increased ON RRP take-up does non expand the size of the Federal Reserve’s residuum canvass or the book of private short-term funding required to finance that residuum sheet. Instead, such an increment shifts the composition of the Federal Reserve’s liabilities from reserves held yesteryear banks to RRPs that tin john live held yesteryear a wider arrive at of institutions. ...This paragraph, next the last, seems to validate just my point.
..., a permanently expanded role for the Federal Reserve inwards curt term funding markets could reshape the fiscal manufacture inwards ways that may live hard to anticipate in addition to that may testify to live undesirable. For example, a permanent or long-lasting facility that causes real meaning crowding out of short-term financing could Pb to atrophying of the private infrastructure that supports these markets. Partially inwards response to some of these concerns, the FOMC has made clear that an ON RRP facility is non intended to live permanent (FOMC 2014c).These markets failed! The run on repo was cardinal to the fiscal crisis! This is similar the 19th century the States deciding that nosotros shouldn't number Federal currency, equally it volition shipping away private banknotes. The Fed seems to run into no work inwards displacing or regulating out of beingness many other contracts in addition to practices. From a flake later
a recent literature has emphasized the benefits of earth provision of prophylactic short-term assets, such equally ON RRPs, inwards enhancing fiscal stability yesteryear displacing private money-like assets that are prone to runs.Yes!
Now, the cardinal dot 2) fiscal stability inwards a run.
3.2. Potential effects of an ON RRP facility on fiscal stability
In principle, at that spot are ii distinct channels through which the establishment of an ON RRP facility could touching on fiscal stability. First, the availability of an elastically supplied risk-free asset could influence the likelihood that coin marketplace seat investors would shift rapidly from providing private short-term funding to asset solely real prophylactic assets. That is, the facility could touching on the jeopardy of a widespread run. Second, an ON RRP facility could touching on the dynamics in addition to severity of such a shift, i time it is nether way.... The academic literature does non provide strong guidance regarding the effects of a novel risk-free asset on the likelihood of abrupt shifts toward prophylactic assets.Again, I recall this is wrong, in addition to confuses the private amongst the aggregate. Sorry to live blunt. Investors wanting to run can, in addition to did, agree banking concern accounts, cash, coin marketplace seat funds invested inwards Treasuries, or short-term treasuries. The aggregate amounts of these are non changing.
It is also quite a curious mental attitude that the Fed should bound the provision of money-like assets inwards a run, in addition to insist that prices plummet instead. By in addition to large the Fed does just the opposite. The Fed flooded the marketplace seat amongst coin inwards the crisis, equally it is supposed to do in addition to volition do again. (As the newspaper explains nicely).
If the Fed does non purchase assets, the private sector cannot inwards total sell them.
Mistaking private flows for aggregate flows is i of the most basic (and easy) errors inwards thinking most fiscal markets. Daily, intelligence outlets enjoin us that "investors fled from stocks to bonds" or vice versa. No they didn't. For every seller at that spot is a buyer.
... i time a run is underway, the availability of ON RRPs could allow greater flight-to-quality flows during a run in addition to hence could exacerbate the run in addition to its effects. These effects mightiness live peculiarly meaning amongst a full-allotment ON RRP facility, but they also could occur amongst facility that does non offering total allocation if its construction leaves the potential for a abrupt in addition to unexpected large increment inwards take-up.But for every dollar of MMF conduct keep up, at that spot must live a dollar less of banking concern conduct keep up. The newspaper says the same thing several times.
3.2.2. Effect on the dynamics in addition to severity of a run (once it is underway)
Absent an ON RRP facility, inwards the lawsuit of a widespread run from private short-term funding markets, the provide of prophylactic assets, such equally Treasury securities, would non expand automatically to conform increased demand. Hence, without ON RRPs, opportunities to run may live constrained yesteryear a limited provide of risk-free assets, in addition to greater demand for those assets is probable to force upwardly their prices in addition to brand running to a greater extent than costly.
By contrast, an ON RRP facility that elastically supplies a real prophylactic asset in addition to which has the potential to increment inwards size yesteryear real large amounts would provide no immediate machinery to irksome a run. Hence, some marketplace seat observers conduct keep suggested that such a facility could exacerbate flight-to-quality flows in addition to their repercussions (Wrightson ICAP 2014).But the RRP facility does non "elastically provide a prophylactic asset," on net. The size of the residuum sheet, in addition to the total amount of reserves, remains fixed. (Except that the Fed volition live dramatically expanding the residuum canvass inwards whatsoever run anyway, buying upwardly all sorts of dodgy debt, non forcing people to sit down on such debt equally this declaration envisions.)
There is a flake of feel inwards this:
... Cash that, inwards the absence of ON RRPs, mightiness conduct keep moved rapidly to liquid deposits at banks could become instead into a risk-free ON RRP facility through, for example, authorities MMFs that invest inwards ON RRPs. The sources of flight-to-quality flows, such equally prime number MMFs, could experience larger outflows than inwards yesteryear episodes, in addition to the availability of short-term funding for broker-dealer in addition to nonfinancial firms through vehicles similar repo in addition to CP could turn down to a greater extent than quickly.It starts yesteryear repeating my puzzle. People who wish to run, tin john run to banking concern accounts. So RRP makes no difference. But (not said), large investors can't instruct insured deposits. So perhaps maybe, an investor asset a prime number fund (invested inwards Lehman debt) would live to a greater extent than probable to run if funds that invested inwards RRP were available?
But... coin marketplace seat funds that invest inwards curt term treasuries rest available. Treasuries themselves are available (we're talking large institutional investors hither non mom in addition to pop.)
Later,
all else equal, increased ON RRP usage implies reduced short-term financing for other borrowers. If, for example, MMFs rapidly shift from investing inwards commercial newspaper or repo to asset ON RRPs, they would trim back the availability of short-term credit for private firms in addition to institutions. More generally, inwards contrast to classic cardinal banking concern liquidity provision, which creates reserves, increased ON RRP take-up diminishes reserves.
I soundless recall this confuses private portfolio shift for aggregates. For a fund to increment ON RRP, it has to instruct reserves from somewhere. If it sells an asset to some other investor inwards central for the reserves, instantly that other investor holds the asset.
We're going some inwards circles, so I'll halt here.
I heard i real adept declaration at tiffin today: If at that spot is a large RRP facility, in addition to if many large coin marketplace seat funds are one-half invested in, say, Greek banking concern debt in addition to one-half invested inwards RRP, so the Fed may experience that these funds are "too large to fail" because they're asset so much reserves, in addition to experience the request to bail them out of their Greek debts. That, however, is a cynical colleague at tiffin in addition to non inwards this paper.
In response to these concerns, the Fed is planning to hobble the effort:
... the FOMC has already indicated inwards its Policy Normalization Principles in addition to Plans that the facility volition live phased out when it is no longer needed to assist command the FFR, in addition to its temporary nature should mitigate some concerns most impacts on short-term funding markets (FOMC 2014c). In addition, caps on ON RRP usage could live imposed to bound the Federal Reserve’s footprint inwards short-term funding markets or to incorporate potentially destabilizing inflows into the facility during periods of fiscal stress.
Last thoughts
On a long airplane flying yesterday I watched Janet Yellen's testimony inwards the Senate Banking Committee. I was impressed yesteryear her masterful treatment of the questions. And I gained a novel appreciation of the political constraints the Fed is operating nether here. Paying large involvement on reserves in addition to opening that upwardly to Wall Street is going to live tough, no thing how groovy equally a thing of economics. I sympathise the strong wish to label monetary policy "normal."
Here I recall the Fed dug itself inwards a flake of a hole. By trumpeting how groovy QE was, in addition to how much stimulation it did, the Fed instantly would bring out it real hard to say "we've been reading Cochrane (and many others) in addition to the huge residuum canvass is doing nil at all stimulative in addition to is kinda dainty for fiscal stability. So we'll simply instruct out it all outstanding in addition to pay IOR, in addition to telephone telephone that 'normal'."
Another colleague's bright tiffin insight. The Fed may conduct keep deliberately dug itself inwards a hole. By buying lots of long-term bonds, the Fed volition conduct keep large grade to marketplace seat losses if involvement rates rise, in addition to halt remitting coin to the Treasury. This is a precommitment non to enhance rates. So, a adept response to "how did QE 'work'" is non simply yesteryear implicitly promising to expire on rates depression for a long time, but yesteryear making it real hard to enhance rates!
