May 30, 2022·edited May 30, 2022

Hmm. I'm getting stuck. I still don't understand why "it is wrong to draw the conclusion that money funds are using the ON RRP facility because there are no better alternative investments."

Where am I going wrong?

If there *were* better alternative investments for money funds, then we'd see:

1. Money funds holding less RRP and more securities.

2. The public holding fewer securities and more deposits.

3. Banks holding more reserves.

Is that correct?

And if there *weren't* better alternative investments for money funds, we'd see:

1. Money funds holding more RRP and fewer securities.

2. The public holding more securities and fewer deposits.

3. Banks holding fewer reserves.

"So if it were the lack of better alternatives that was stopping money funds from reducing ON RRP balances, we should see steady balances of bank reserves, or even increasing balances if banks faced the same problem."

Why would the lack of better alternatives cause steady or increasing reserves?

"In fact, banks are reducing reserve balances, while money fund ON RRP balances are expanding."

I don't understand why this isn't exactly what you'd expect if money funds were using ON RRP because there were no better alternative investments.

"Reserves pay 90 bp, ON RRP pays 80: money is moving from the higher- to the lower-interest investment."

Right, but money has to move in this direction the public is pulling out its deposits from the banking sector to buy securities from the money funds. Right?

"Conclusion: banks are reducing reserve balances because they want to, for a reason other than interest rates."

They're not reducing their reserve balances because ON RRP is causing a reserve drain out of the banking system as a whole?

"ON RRP, meanwhile, sets a floor under interest rates: it is literally the worst asset money funds can buy. Yet ON RRP deposits are increasing to record levels. Conclusion: money funds don’t have control over ON RRP balances."

If money funds had better investments, what prevents them from moving out of RRP?

"Banks are contracting reserves because they can, money funds are expanding overnight repo because they have to."

I'm not convinced. But like I said, I might be missing something.

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This is very interesting. Why would banks willingly reduce reserves? As reserves attract penalty from SLR, I assume banks have more profitable uses for their balance sheet.

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At the same time, banks have increased loans to the public (reserves decreased but replaced with other assets) and the banks deposits created have been destroyed to go in MMFs->ONRRP. It is as if banks lend to the public for the public to put it in ONRRP

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Also, could it be that there is one '+ Reserves' missing in line (3) in the Banks' T account? Many thanks for your precious precious work!

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Many thanks, very interesting.

What is the reason for MMMFs to increase ONRRP then? What do you suggest when you say that they have 'no control' over it? Many thanks in advance!

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