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Initiative and post-pandemic monetary policy
The Fed looks ahead to a world of standing facilities
The minutes of the FOMC's June meeting, released this week, show discussion of two new standing repo facilities to go with the central bank's existing RRP facility. According to the minutes, the discussion in the meeting approached these as policy plans for the medium term. But the discussions are taking place now, not in the future, and so they give us a read on how monetary policymakers are thinking about policymaking now.
Absorbing reserves: the ON RRP facility
Repo, from the Fed's point of view, is an asset, a loan of money secured by a loan of securities in the opposite direction. The Fed conducts repo transactions to lend money into the financial system. Reverse repo, again from the Fed's point of view, is the same type of transaction in the opposite direction—a deposit of money secured by a deposit of securities, recorded as a liability to the Fed.
The overnight reverse repo facility, which already exists, is a deposit facility: it is a way for the Fed to absorb reserves. The ON RRP has been used to absorb the reserves created by the Fed's asset purchases over the course of the pandemic, and especially since March of this year. By giving money market mutual funds a claim on the Federal Reserve, the ON RRP facility allows banks to reduce their reserves.
Adding reserves: the SRF and the FIMA repo facility
At the June meeting, the FOMC discussed two proposed lending facilities, a standing repo facility (SRF) and a foreign international monetary authorities (FIMA) standing repo facility. Both would work on the other side of the balance sheet, as assets to the Fed, loans of funds to add reserves to the financial system. The two facilities differ from each other in that the SRF would be for domestic use, with primary dealers as the main counterparty, while the FIMA facility would be for international use, with foreign central banks as the main counterparty.
The SRF would allow securities dealers to borrow from the Fed using a repo transaction, priced at the upper limit of the Fed Funds target range. The proceeds could then (for example) be lent out in another repo transaction, perhaps with a bank, which would in turn increase the bank's reserves at the Fed. A sketch of the SRF in T accounts:
The SRF is a way to add reserves to the US financial system. For the moment this need is hypothetical, as the Fed is still adding reserves by purchasing assets. That Fed officials are discussing a standing repo facility is an indication that they are planning for a future regime in which conditions are quite different. In that world, as the minutes show, the FOMC would like to be providing a backstop, allowing private markets to handle most of the volume within a narrow policy-determined range of prices. Priced at the limits of that range, the SRF and the ON RRP facilities would be available to add and remove reserves.
The balance-sheet structure of the standing repo facility is very similar to the normal open-market operations used by the Fed before the 2008 crisis. A crucial difference, however, is that those operations were typically taken on the Fed's own initiative. The central bank transacted in anticpation of forecasted funding needs, and primary dealers were obligated to act as their counterparties. In the standing facility, by contrast, the Fed would transact on the initiative of its repo counterparties.
The same logic applies to the second facility that was discussed at the June meeting. The FIMA repo facility was established as a temporary intervention in March 2020, at the beginning of the pandemic; discussion in the June 2021 meeting is around making it permanent. Like the SRF, FIMA repo is a way for the Fed to provide dollar funding. Here, however, the focus is on international dollar liquidity: the Fed would lend dollars to foreign central banks through repo transactions. These central banks could use the proceeds to provide dollar financing to their banking systems. Here is one way that it could work:
The FIMA repo facility would likely replace the central bank liquidity swap lines that were used to provide dollar funding to non-US banks during the 2008 crisis. This FIMA facility, unlike the swap lines, is entirely in dollars: central banks using the facility would have to come up with USD securities for collateral. It is a less symmetrical arrangement than the swap lines in that it assumes that there would be an non-US need for dollar financing, while making no provision for the reverse, a US need for non-dollar liquidity. This would seem to accept the reality of US dollar hegemony.
What to expect
What all three these standing facilities–ON RRP, SRF, and FIMA repo—have in common is that they are ways by which the Fed would transact when its counterparties want to. These are all ideas for a "non-crisis" footing, different from the in-crisis $120 billion per month asset purchases, which happen on the Fed's initiative. The Fed is imagining a world in which it can step out of day-to-day market-making, instead setting bounds on market-making by others.
What's interesting to me about this is the interplay between initiative and constraint. The Fed wants to use standing facilities to set prices; at those prices, its counterparties can determine the level of the facilities' usage, which the Fed commits to accommodating. Minsky wrote that "[i]n its very essence the central bank is the operator of the discretionary element in the financial system" (emphasis mine). The Fed has a flexibility that no other actor has, and, as the June minutes show, it is thinking now about how to re-deploy that discretionary element.