Fed reverse repo tests
Posted by WARREN MOSLER on December 24th, 2009
Repo testing???
This is downright embarrassing:
Fed’s Reverse Repo Tests Going Well, Industry Group Head Says
By Liz Capo McCormick
Dec. 23 (Bloomberg) — Federal Reservetests of tri-party reverse repurchase agreements have “gone extremely well,” according to the head of the industry group working with the central bank on the transactions.
The Federal Reserve Bank of New York has drained $990 million in reserves from the banking system through five trials this month as part of its “tri-party reverse repo operational readiness program” announced Nov. 30. The central bank stressed at that time that the tests don’t represent a change in policy and were one tool at its disposal for the eventual withdrawal of the unprecedented monetary stimulus added to the economy.
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December 24th, 2009 at 12:32 pm
Of course, if the Fed really believes this stuff, it is insane. But could it just be a signal that the Fed is sending to reduce “inflationary expectations” that it sees building? There is a whole lot of craziness about this floating around. Some of it is excusable ignorance, but good deal of it is from people who should know better.
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December 24th, 2009 at 3:09 pm
If I understand it correctly, the Fed is testing, if the private sector or banks are willing to buy some assets from the Fed, correct?
If so, why is it embarassing?
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December 24th, 2009 at 5:15 pm
it doesn’t matter if anything is bought or not. it’s all about interest rates, not quantities.
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December 25th, 2009 at 1:32 pm
If nothing is bought, how does the interest rate get changed?
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December 25th, 2009 at 2:25 pm
Hi Warren,
There is one thing they are missing. Agencies are getting paid no interest on reserves. I think this will trouble them and cause them more embarassment.
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December 25th, 2009 at 5:59 pm
cur- if you know the interest rate you can get at the fed would you invest anywhere for less than that? the rate the fed offers sets the floor.
Ram- yes, they are in the processof being able to interest on all reserves.
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Richard Benson Reply:
December 26th, 2009 at 2:39 pm
“If you know the interest rate you can get at the fed would you invest anywhere for less than that? the rate the fed offers sets the floor.”
Warren I have heard talk in some academic circles about the effects of charging 2% – IE negative rates – if the floor was -2% instead of 0 – what do you see happening at the macro level?
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December 25th, 2009 at 10:37 pm
I see. Because the Fed pays interest on reserves, correct? That makes sense.
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December 26th, 2009 at 2:46 pm
negative rates:
even if negative rates did somehow ‘work’ to increase demand, i’d rather increase demand via lower FICA taxes than more consumer debt. Just my personal bias. I feel better about spending because my income is higher, than spending because what funds I have saved are getting taxed away.
however, seems to me negative rates are just another tax on banks if you also sustain excess reserves, and would further reduce income for savers and thereby reduce demand through that channel as well. So I don’t see it as doing much good for agg demand even if you did want to increase demand via higher private sector debt/lower savings.
I’d be surprised if whoever came up with the idea of negative rates had any idea how the monetary system actually works
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Scott Fullwiler Reply:
December 26th, 2009 at 11:43 pm
Agree re: negative rates with Warren
Same goes for negative rates on excess reserves only (excess reserve tax). I dealt with this twice in July on the KC blog, FYI.
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Curious Reply:
December 26th, 2009 at 11:48 pm
Can you post a link Scott? Thanks.
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Curious Reply:
December 27th, 2009 at 12:04 am
Never mind, I found it. For those interested:
http://neweconomicperspectives.blogspot.com/2009/07/why-negative-nominal-interest-rates.html
http://neweconomicperspectives.blogspot.com/2009/07/why-negative-nominal-interest-rates_14.html
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December 29th, 2009 at 6:27 am
http://www.ft.com/cms/s/0/bdcc9a80-f3e0-11de-ac55-00144feab49a.html
For access with no subscription First result : http://www.google.com/search?hl=en&source=hp&q=%22fed+to+offer+term+deposits+to+banks%22+FT&btnG=Google+Search&aq=f&oq=&aqi=
This is either a good trick to absorb agencies’ reserves so that the target can be achieved or just the same misunderstanding about “lending out the reserves” and “money pouring in on the economy”
Anyway as Warren says they are in the process of getting powers to pay interest to agencies’ reserves – so the term deposits not needed -any target can be achieved and no “exit strategy” needed. Right ?
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December 29th, 2009 at 7:12 am
Right.
This exit strategy stuff might just be about managing expectations of those who don’t understand monetary operations.
In that case I’d do that by providing a continuous basic education, beginning with the FOMC of course. Not acting ‘out of paradigm’ with inapplicable ‘exit strategies’
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December 29th, 2009 at 9:53 am
If overnight or term deposits for excess reserves are functionally the same as Treasury securities, doesn’t that also mean that excess reserves that the Fed pays interest on should be defined as private sector savings? The BEA listed net private sector savings of $898bn in Q209, which apparently does not take into account $1+ trillion in excess reserves on account with the Fed.
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December 29th, 2009 at 10:00 am
there are many measures of ‘savings’
net financial assets = cash in circulation, reserves, and tsy secs outstanding, for example
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December 29th, 2009 at 10:32 am
Right. So, the 4.5% personal savings rate reprted by the BEA significantly understates the actual savings rate?
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December 29th, 2009 at 2:48 pm
don’t know the details. no time to check, sorry!
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December 29th, 2009 at 4:09 pm
Ed,
Writing without checking but my suspicion is that their (BEA) math is correct.
The excess reserves came into existence because the private sector sold the Treasuries and MBSs to the Fed. Nothing new has been “created” here in some sense.
Imagine a simple day – nothing happens: no government spending, no taxes, no treasury auction, no private sector activity like consumption, investment etc. Except that the Fed just buys $1b of Treasuries from a bank and pays reserves worth $1b. Saving of the private sector has not increased – its just the composition of the balance sheet which has changed.
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December 29th, 2009 at 5:02 pm
The BEA number of $ 898 billion annualized is correct as a Q2 flow item – the amount of income saved during that quarter. You have to be careful in relating flow items to stock or balance sheet items. Stock items are a reflection of cumulative flow items. The $ 1 trillion in excess reserves is a stock item. It can only be included in a saving calculation correctly as part of total cumulative saving over time. And it can only be included as a gross item. As Ramanan says, you also have to net against it any holdings of the government sector in the private sector, which in this case includes Fed lending to the private sector, in order to calculate the cumulative saving position of the private sector. In any event, the $ 1 trillion in excess reserves at the time (if that’s what it was) bears virtually no direct relationship to the $ 898 billion flow in saving during that quarter.
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JKH Reply:
December 29th, 2009 at 5:08 pm
P.S.
To the degree that private sector saving during that quarter included net saving with the government, it was probably reflected mostly in net new issuance of treasury debt, not in changes in the excess reserve position.
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December 29th, 2009 at 7:18 pm
Ramanan, JKH,
Thanks guys. Your feedback helps my understanding a great deal.
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January 6th, 2010 at 1:57 pm
On a tangential note, I think the Fed doesn’t use reverse repos much for Open Market Operations. $990m for a “test” is a small number! Treasury sales drain reserves created by the Government spending. The Fed uses outright sales of Treasuries from its own balance sheet sometimes. Return of discount window loans drains reserves as well as well as discontinuation of (some) repos. TT&L account manipulation does a lot of fine tuning for the Fed I think.
Page 12 (Page 14 of the pdf) of this document http://www.newyorkfed.org/markets/omo/omo2008.pdf says that they don’t use RRP much. Though in 2008 the size was higher than precrisis days.
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