“ON RRP Operations as a Monetary Policy Tool:
Some Design Considerations”
by
Josh Frost, Lorie Logan, Antoine Martin,
Patrick McCabe, Fabio Natalucci, and Julie Ramache
Presentation at the 3rd NYU Economics PhD Alumni Conference
May 29-30, 2015
The views expressed here are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board
of Governors of the Federal Reserve System or its staff.
Overview of the Paper
•
Review recent changes in monetary policy that have led to the development and testing of
an ON RRP facility
–
“A Federal Reserve facility that conducts overnight (ON) reverse repurchase agreements (RRPs) with
eligible counterparties. An RRP is an open market operation (OMO) in which the FRBNY Desk sells a
security to the counterparty with an agreement to repurchase that same security at a specified price at a
specific time in the future. The transaction is economically similar to the counterparty lending to the Fed,
with the security serving as collateral for the loan. The difference between the sale price and the
repurchase price, together with the length of time between the sale and purchase, implies a rate of
interest paid by the Federal Reserve on the cash invested by the RRP counterparty.”
•
Explain usefulness of ON RRPs for implementing monetary policy during normalization
•
Examine secondary effects of an ON RRP facility
–
–
Federal Reserve footprint in short-term funding markets
Financial stability implications (positive and negative)
•
Investigate design features of an ON RRP facility that could mitigate undesirable secondary
effects
•
Discuss tradeoffs policymakers face in designing an ON RRP facility
–
Balance objectives of setting effective floor on money markets during normalization and limiting adverse
secondary effects
1
Operating Framework before the Financial Crisis
• Before the financial crisis, the FOMC conducted
monetary policy by setting a target for ON FFR
– The Desk transacted with PDs to adjust the supply of
reserves so that, for a given level of demand, marketclearing FFR would be consistent with the target
• “Corridor” operating framework
– The Desk made outright purchases of Treasury securities
and conducted temporary, fine-tuning operations in the
form of RPs and RRPs in markets for gov’t securities
• The Desk maintained a “structural deficiency” in reserves, so finetuning operations were primarily RPs that temporarily boosted
reserves
2
Federal Reserve Response to the Crisis
• The Federal Reserve responses to the financial crisis
included important changes to the conduct of monetary
policy
– Reduction of FFR from 5 ¼ to a target range of zero to ¼
– Introduction of a number of facilities to provide liquidity to
financial institutions in order to maintain the flow of credit and
improve financial market conditions
– Asset purchases to put downward pressure on long-term rates
– Forward guidance regarding the path of FFR
3
Federal Reserve Balance Sheet
4
Introduction of Interest on Excess Reserves
• Starting in October 2008, the Federal Reserve has been authorized to pay
interest on reserves held by DIs
• In the current environment in which the supply of reserves far exceeds
the amount needed for reserve requirements, IOER has become the
primary tool of monetary policy
– “Floor” operating system
• IOER is not available to MMFs, other cash-management vehicles,
nonfinancial corporations, and GSEs
– In the absence of frictions, competitions should push money market rates
close to IOER
• In practice, arbitrage across money market rates is not costless
– Balance sheet costs related to FDIC assessment fee, Basel III leverage ratio
– These costs drive a wedge between IOER and other money market rates
5
Selected Money Market Rates
• IOER alone does not set a firm floor under money market
rates
6
ON RRP as a Complement to IOER
• One way to strengthen the floor on short-term interest rates is to
offer an ON, risk-free instrument to a wider range of market
participants
– An RRP is economically equivalent to a loan to the Federal Reserve
collateralized by securities in the SOMA portfolio
• The ON RRP rate is a risk-free rate set by the Federal Reserve
available to nonbank investors active in money markets
– Currently 163 RRP counterparties, including PDs (22), banks (24), GSEs (12)
and MMFs (105)
• Access to ON RRPs should increase competitiveness in money
markets and strengthen effectiveness of floor on short-term rates
– The option to invest in ON RRPs should provide bargaining power to investors
with access to the ON RRP rate in their negotiations with borrowers in money
markets
7
“Policy Normalization Principles and Plans”
• When economic conditions and the economic outlook warrant a
less accommodative monetary policy, the Committee will raise its
target range for the federal funds rate.
• During normalization, the Federal Reserve intends to move the
federal funds rate into the target range set by the FOMC primarily
by adjusting the interest rate it pays on excess reserve balances.
• During normalization, the Federal Reserve intends to use an
overnight reverse repurchase agreement facility and other
supplementary tools as needed to help control the federal funds
rate. The Committee will use an overnight reverse repurchase
agreement facility only to the extent necessary and will phase it out
when it is no longer needed to help control the federal funds rate.
8
ON RRP Testing
• Testing to date suggests that the ON RRP exercise has helped
control short-term rates
9
ON RRP Testing (cont’d)
• ON RRP take-up to date and caps
10
ON RRP Testing (cont’d)
• ON RRP take-up increases when the spread between market
rates and ON RRP rate narrows
11
Some Potential Secondary Effects
• An ON RRP facility offered in full allotment, or even in very
large amounts, could have significant secondary effects
– Footprint: Expansion of Federal Reserve intermediation in shortterm funding markets (particularly if the facility were permanent)
could alter financial intermediation in unpredictable ways
• Increased ON RRP take-up does not expand Federal Reserve balance
sheet, it shifts the composition of the liabilities from reserves to RRPs
– Financial stability implications
• Beneficial effects: The public provision of a safe, short-term asset could
displace seemingly safe, seemingly liquid private assets prone to run
• Negative effects: A facility that allows for a very rapid expansion of ON
RRPs might exacerbate disruptive FTQ flows during period of financial
stress and thus undermine financial stability
12
Footprint Considerations
• An ON RRP facility could expand the Federal Reserve
role in financial markets by offering investors a new
tool to manage liquidity and thus crowd out some
private financing
– Extent of crowding out would largely depend on the
elasticity of demand of private financing
• Permanently expanded role for the Federal Reserve in
short-term funding markets could reshape the financial
industry in ways difficult to anticipate and that may
prove undesirable
– Could lead to atrophy of private infrastructures
13
Footprint Considerations (cont’d)
• ON RRPs may have served as a substitute for some private
financing, although decline may also have reflected other
unrelated factors
14
Financial Stability Considerations
• Two distinct channels through which an ON
RRP facility could affect financial stability
– First, availability of an elastically supplied risk-free asset
could influence the likelihood that money market investors
would rapidly shift from providing private short-term
funding to holding only very safe assets
• Second, an ON RRP facility could affect the dynamics and
severity of a run once a run is underway
15
Effects on the Dynamics and Severity of a Run
• Absent an ON RRP facility, in the event of a run from
private short-term funding markets, the supply of safe
assets (such as Treasury securities) would not expand
automatically to accommodate greater demand
– Prices of safe assets would rise, making the run more costly
• An ON RRP facility that elastically supplies a very safe asset
provides no mechanism to slow the run
– Although it could diminish the incentive to front-run other
investors seeking to buy Treasuries or invest in gov’t-only MMFs
17
Flight-to-Quality Flows in 2008
• In the week of September 15-19, 2008, when the Lehman bankruptcy
caused losses at prime MMFs and the Reserve Fund “broke the buck,” a
variety of safe havens attracted inflows as investors ran from every shortterm vehicle that embedded liquidity and credit risk
18
How Could a Large ON RRP Facility Alter FTQ Flows?
• Flight-to-quality flows witnessed in previous stress episodes can
provide a benchmark for the scale of flows that might be redirected
to an ON RRP facility
• But there could be additional safe-haven flows because of the
existence of a new risk-free asset like ON RRPs
– Greater within portfolio shifts to safe assets by MMFs that are ON RRP
counterparties
– Larger redemptions from prime MMFs and inflows into gov’t MMFs
that hold ON RRPs
– Larger inflows into these gov’t MMFs from other sources
• The ultimate effect on financial stability and economic activity
would depend on the nature of the institutions and firms that
might lose short-term funding if investors shifts to ON RRPs
19
ON RRP Facility Design
• A number of possible design features and safeguards
for an ON RRP facility could limit the role of the
Federal Reserve in financial intermediation and
constrain sudden, sharp increases in take-up that
might threaten financial stability
–
–
–
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Making an ON RRP facility temporary
Changes in the ON RRP rate
Quantity controls
Combinations of rate and quantity controls
20
Setting a Cap on ON RRP Facility Size
• Individual caps vs an aggregate cap
– If counterparties’ demand for ON RRP is not perfectly correlated, an
aggregate cap allows for more favorable tradeoff between limiting
facility size and potential surges and avoiding frequent binding
instances in normal market conditions
– An auction provides a market-based mechanism to allocate usage
• Single-price auction used in the current exercise if $300 billion cap is binding
• Static vs dynamic, circuit-breaker cap
– Circuit-breaker cap can be used to control potential one-day surges in
ON RRP usage
• It adjusts automatically to accommodate changing demand and market
conditions, keeping the size of potential jumps in usage within a narrow range
– Example: Dynamic cap set as ON RRP usage over previous 5 days plus
$100 billion
21
ON RRP Take-up and Static and Dynamic Caps
22
Tradeoffs in Design of ON RRP Facility
• Policymakers may face tradeoffs in designing an
ON RRP facility as they seek to balance
potentially competing objectives:
– Setting an effective floor on money market rates
– Minimizing the unintended consequences of a large
footprint in short-term funding markets
– Limiting risks to financial stability
• These tradeoffs are likely to evolve over time
– Implementation of new capital and liquidity rules
– Role of ZLB
23