The Fed's balance sheet over the last half-cycle
Thanks Daniel for the clear exposition of balance sheet mechanics. I am worried the Fed is too sanguine about how the RRP will operate under balance sheet reduction. Just because it ran up to $1.7 trillion so easily doesn't mean it will be the first part of the balance sheet to shrink in QT. For instance, money-market funds need incentive to switch out of the flexible RRP into market securities (for instance T-Bills), yet the return on T-Bills is virtually identical to the expected return on RRP reflected in the Fed Fund futures strip. Will the Fed need to introduce a penalty rate on RRP?
This could be important for wider financial stability issues because if RRP fails to decline as expected on balance sheet run-off then bank reserves are required to fall with the possible impact on securities settlement and repo markets.
Hi Daniel, great piece. Why the introduction of equity in the most recent diagram? Thanks