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.
I am also interested in this question. I'm not sure what to think about it yet, but for now am suggesting The Fed Guy: https://fedguy.com/draining-the-rrp/
It's a way of thinking about what the Treasury gets when it spends. That spending was in the form of stimulus checks, so there's nothing concrete on the other side. I think of it as "equity" as a way of indicating that the Treasury gets a residual claim on the public, which it has some (but not unlimited) power to collect through taxes. So it's a shorthand.
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.
I am also interested in this question. I'm not sure what to think about it yet, but for now am suggesting The Fed Guy: https://fedguy.com/draining-the-rrp/
Hi Daniel, great piece. Why the introduction of equity in the most recent diagram? Thanks
It's a way of thinking about what the Treasury gets when it spends. That spending was in the form of stimulus checks, so there's nothing concrete on the other side. I think of it as "equity" as a way of indicating that the Treasury gets a residual claim on the public, which it has some (but not unlimited) power to collect through taxes. So it's a shorthand.