From Policy Rates to Market Rates—Untangling the U.S. Dollar Funding Market
How do changes in the interest rate that the Federal Reserve pays on reserves affect interest rates in money markets in which the Fed does not participate? And through which channels do changes in the so-called administered rates influence rates in onshore and offshore U.S. dollar money markets? This post offers an interactive map illustrating the web of relationships between the Fed, key market players, and the various instruments in the U.S. dollar funding market.
When Do Trade Frictions Increase Liquidity?
Economists tend to assume that frictions that limit trading in financial markets reduce liquidity and lower investor welfare. In this blog I discuss a recent staff study of mine that challenges that conventional wisdom. I explain how introducing trading frictions—such as circuit breakers—that slow or halt trading in an over-the-counter market experiencing a fire sale might, paradoxically, lead to higher liquidity and investor welfare.
A New Reserves Regime? COVID-19 and the Federal Reserve Balance Sheet
Aggregate reserves declined from nearly $3 trillion in August 2014 to $1.4 trillion in mid-September 2019, as the Federal Reserve normalized its balance sheet. This decline came to a halt in September 2019 when the Federal Reserve responded to turmoil in short-term money markets, with reserves fluctuating around $1.6 trillion in the early months of 2020. Then, in response to the COVID-19 pandemic, the Federal Reserve dramatically expanded its balance sheet, both directly, through outright purchases and repurchase agreements, and indirectly, as a consequence of the facilities to support market ...
The Market Events of Mid-September 2019
This paper studies the mid-September 2019 stress in U.S. money markets: On September 16 and 17, unsecured and secured funding rates spiked up and, on September 17, the effective federal funds rate broke the ceiling of the Federal Open Market Committee (FOMC) target range. We highlight two factors that may have contributed to these events. First, reserves may have become scarce for at least some depository institutions, in the sense that these institutions’ reserve holdings may have been close to, or lower than, their desired level. Moreover, frictions in the interbank market may have ...
How Have High Reserves and New Policy Tools Reshaped the Fed Funds Market?
Over the last decade, the federal funds market has evolved to accommodate new policy tools such as interest on reserves and the overnight reverse repo facility. Trading motives have also responded to the expansion in aggregate reserves as the result of large-scale asset purchases. These changes have affected market participants differently since, for instance, not all institutions are required to keep reserves at the Fed and some are not eligible to earn interest on reserves. Differential effects have changed the profile of participants willing to borrow and lend in this market, and this ...
How Bank Reserves Are Distributed Matters. How You Measure Their Distribution Matters Too.
Changes in the distribution of banks’ reserve balances are important since they may impact conditions in the federal funds market and alter trading dynamics in money markets more generally. In this post, we propose using the Lorenz curve and Gini coefficient as a new approach to measuring reserve concentration. Since 2013, concentration, as captured by the Lorenz curve and the Gini coefficient, has co-moved with aggregate reserves, decreasing as aggregate reserves declined (such as in 2015-18) and increasing as aggregate reserves increased (such as at the onset of the COVID-19 pandemic).
Mission Almost Impossible: Developing a Simple Measure of Pass-Through Efficiency
Short-term credit markets have evolved significantly over the past ten years in response to unprecedentedly high levels of reserve balances, a host of regulatory changes, and the introduction of new monetary policy tools. Have these and other developments affected the way monetary policy shifts “pass through” to money markets and, ultimately, to households and firms? In this post, we discuss a new measure of pass‑through efficiency, proposed by economists Darrell Duffie and Arvind Krishnamurthy at the Federal Reserve’s 2016 Jackson Hole summit.
Monetary Policy Implementation With an Ample Supply of Reserves
Methods of monetary policy implementation continue to change. The level of reserve supply—scarce, abundant, or somewhere in between—has implications for the efficiency and effectiveness of an implementation regime. The money market events of September 2019 highlight the need for an analytical framework to better understand implementation regimes. We discuss major issues relevant to the choice of an implementation regime, using a parsimonious framework and drawing from the experience in the United States since the 2007-2009 financial crisis. We find that the optimal level of reserve supply ...
Coming to Terms with Operational Risk
The term ?operational risk? often evokes images of catastrophic events like hurricanes and earthquakes. For financial institutions, however, operational risk has a broader scope, encompassing losses related to fraud, rogue trading, product misrepresentation, computer and system failures, and cyberattacks, among other things. In this blog post, we discuss how operational risk has come into greater focus over the past two decades?to the point that it now accounts for more than a quarter of financial institutions? regulatory capital.
Monetary Policy Implementation with an Ample Supply of Reserves
Methods of monetary policy implementation continue to change. The level of reserve supply—scarce, abundant, or somewhere in between—has implications for the efficiency and effectiveness of an implementation regime. The money market events of September 2019 highlight the need for an analytical framework to better understand implementation regimes. We discuss major issues relevant to the choice of an implementation regime, using a parsimonious framework and drawing from the experience in the United States since the 2007–09 financial crisis. We find that the optimal level of reserve supply ...