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Working Paper
Financial Stress and Equilibrium Dynamics in Money Markets
Interest rate spreads are widely-used indicators of funding pressures and market functioning in money markets. Using weekly data from 2002 to 2015, we analyze money market dynamics in a long-run equilibrium framework where commonly-monitored spreads serve as error correction terms. We find strong evidence for nonlinearities with respect to levels of the spreads. We provide point and interval estimates for spread thresholds that quantify funding pressure points from a long-run perspective. Our results indicate significant asymmetry in the adjustment toward long-run equilibrium. We show that ...
Working Paper
What does financial volatility tell us about macroeconomic fluctuations?
This paper provides an extensive analysis of the predictive ability of financial volatility measures for economic activity. We construct monthly measures of aggregated and industry-level stock volatility, and bond market volatility from daily returns. We model log financial volatility as composed of a long-run component that is common across all series, and a short-run component. If volatility has components, volatility proxies are characterized by large measurement error, which veils analysis of their fundamental information and relationship with the economy. We find that there are ...
Discussion Paper
An Analysis of the Interest Rate Risk of the Federal Reserve’s Balance Sheet, Part 2: Projections under Alternative Interest Rate Paths
As discussed in the first note of this two-note series, net income of the Federal Reserve (Fed) and its remittances to the U.S. Treasury along with the unrealized gain or loss position of the System Open Market Account (SOMA) portfolio are affected by fluctuations in interest rates. The need for the Fed to increase the policy rate expeditiously to address the inflationary pressures is projected to result in the Fed's net income turning negative temporarily.
Working Paper
The Fed’s “Ample-Reserves” Approach to Implementing Monetary Policy
We describe the Federal Reserve’s (the Fed’s) approach to implementing monetary policy in an ample-reserves regime. We use a stylized model to explain the factors the Fed considers and the tools it uses to ensure interest rate control when the quantity of reserves is ample. Then, we take a close look at the Fed’s experience operating in this regime in the post-crisis period, both as it has raised and lowered its policy rate. Looking ahead, we highlight some considerations relevant for maintaining a level of reserves consistent with the efficient and effective implementation of ...
Working Paper
Effects of Changing Monetary and Regulatory Policy on Overnight Money Markets
Money markets have been operating under a new monetary policy implementation framework since the Federal Reserve started paying interest on bank reserves in late 2008. The regulatory environment has also evolved substantially over this period. We develop and test hypotheses regarding the effects of changes in the monetary and regulatory policy on dynamics of key overnight funding markets. We find that the federal funds rate continued to provide an anchor, albeit weaker, for unsecured funding rates amid substantial decline in activity and changing composition of trades, while its transmission ...
Working Paper
Are Repo Markets Fragile? Evidence from September 2019
We show that the segmented structure of the U.S. Treasury repo market, in which some participants have limited access across the segments, leads to rate dispersion, even in this essentially riskless market. Using confidential data on repo trading, we demonstrate how the rate dispersion between the centrally cleared and over-the-counter (OTC) segments of the Treasury repo market was exacerbated during the stress episode of September 2019. Our results highlight that, while segmentation can increase fragility in the repo market, the presence of strong trading relationships in the OTC segment ...
Discussion Paper
An Analysis of the Interest Rate Risk of the Federal Reserve’s Balance Sheet, Part 1: Background and Historical Perspective
As part of its implementation of monetary policy, the Federal Reserve (Fed) holds Treasury securities and agency mortgage-backed securities (MBS) in the System Open Market Account (SOMA). The market value of these securities and the Fed's income fluctuate with changes in interest rates. As such, the ongoing increases in policy rates to address inflationary pressures are expected to put downward pressure on the Fed's net income.
Working Paper
The Regulatory and Monetary Policy Nexus in the Repo Market
We examine the interaction of regulatory reforms and changes in monetary policy in the U.S. repo market. Using a proprietary data set of repo transactions, we find that differences in regional implementation of Basel III capital reforms intensified European dealers' window-dressing by 80%. Money funds eligible to use the Fed's reverse repo (RRP) facility cut their private lending almost by half and instead lent to the Fed when European dealers withdraw, contributing to smooth implementation of Basel III. In a difference-in-differences setting, we show that ineligible funds lent 15% less to ...
Working Paper
A Dynamic Factor Model of the Yield Curve as a Predictor of the Economy
In this paper, we propose an econometric model of the joint dynamic relationship between the yield curve and the economy to predict business cycles. We examine the predictive value of the yield curve to forecast future economic growth as well as the beginning and end of economic recessions at the monthly frequency. The proposed nonlinear multivariate dynamic factor model takes into account not only the popular term spread but also information extracted from the level and curvature of the yield curve and from macroeconomic variables. The nonlinear model is used to investigate the ...
Working Paper
What does financial volatility tell us about macroeconomic fluctuations?
This paper provides an extensive analysis of the predictive ability of financial volatility measures for economic activity. We construct monthly measures of stock and bond market volatility from daily returns and model volatility as composed of a long-run component that is common across all series, and a set of idiosyncratic short-run components. Based on powerful in-sample predictive ability tests, we find that the stock volatility measures and the common factor significantly improve short-term forecasts of conventional financial indicators. A real-time out of sample assessment yields a ...