How Do Deposit Rates Respond to Monetary Policy?
When the Federal Open Market Committee (FOMC) wants to raise the target range for the fed funds rate, it raises the interest on reserve balances (IORB) paid to banks, the primary credit rate offered to banks, and the award rate paid to participants that invest in the overnight reverse repo (ON RRP) market to keep the fed funds rate within the target range (see prior Liberty Street Economics posts on this topic). When these rates change, market participants respond by adjusting the valuation of financial products, of which a significant category is deposits. Understanding how deposit terms adapt to changes in policy rates is important to understanding the impact of monetary policy more broadly. In this post, we evaluate the pass through of the fed funds rate to deposit rates (that is, deposit betas) over the past several interest rate cycles and discuss factors that affect deposit rates.
How the Fed Adjusts the Fed Funds Rate within Its Target Range
At its June 2021 meeting, the FOMC maintained its target range for the fed funds rate at 0 to 25 basis points, while two of the Federal Reserve’s administered rates—interest on reserve balances and the overnight reverse repo (ON RRP) facility offering rate—each were increased by 5 basis points. What do these two simultaneous decisions mean? In today’s post, we look at “technical adjustments”—a tool the Fed can deploy to keep the FOMC’s policy rate well within the target range and support smooth market functioning.
How the Fed’s Overnight Reverse Repo Facility Works
Daily take-up at the overnight reverse repo (ON RRP) facility increased from less than $1 billion in early March 2021 to just under $2 trillion on December 31, 2021. In the second post in this series, we take a closer look at this important tool in the Federal Reserve’s monetary policy implementation framework and discuss the factors behind the recent increase in volume.
How the Federal Reserve’s Monetary Policy Implementation Framework Has Evolved
In a series of four posts, we review key elements of the Federal Reserve’s monetary policy implementation framework. The framework has changed markedly in the last two decades. Prior to the global financial crisis, the Fed used a system of scarce reserves and fine-tuned the supply of reserves to maintain rate control. However, since then, the Fed has operated in a floor system, where active management of the supply of reserves no longer plays a role in rate control, but rather the Fed’s administered rates influence the federal funds rate. In this first post, we discuss the salient features of the implementation framework in a stylized way.
How Bank Reserves Are Distributed Matters. How You Measure Their Distribution Matters Too.
Changes in the distribution of banks’ reserve balances are important since they may impact conditions in the federal funds market and alter trading dynamics in money markets more generally. In this post, we propose using the Lorenz curve and Gini coefficient as a new approach to measuring reserve concentration. Since 2013, concentration, as captured by the Lorenz curve and the Gini coefficient, has co-moved with aggregate reserves, decreasing as aggregate reserves declined (such as in 2015-18) and increasing as aggregate reserves increased (such as at the onset of the COVID-19 pandemic).
The Fed Funds Market during the 2007-09 Financial Crisis
The U.S. federal funds market played a central role in the financial system during the 2007-09 crisis, because it was the market which provided banks with immediate liquidity, even late in the day. Interpreting changes in fed funds rates is notoriously difficult, however, as many of the economic drivers behind the rates are simultaneously changing. In this post, I highlight results from a working paper which untangles the impact of these economic drivers and measures their respective effects on the marketplace using data over a sample period leading up to and during the financial crisis. The analysis shows that the spread between fed funds sold and bought widened because of increases in counterparty risk. Further, there was a large increase in the supply of cash into this market, suggesting that banks viewed fed funds as a relatively safe place to invest cash in a crisis environment.
Explaining the Puzzling Behavior of Short-Term Money Market Rates
Since 2008, the Federal Reserve has dramatically increased the supply of bank reserves, effectively adopting a floor system for monetary policy implementation. Since then, the behavior of short-term money market rates has been at times puzzling. In particular, short-term rates have been surprisingly firm in recent months, despite the large increase in reserves by the Fed as a part of its response to the coronavirus pandemic. In this post, we provide evidence that both the supply of reserves and the supply of short-term Treasury securities are important factors for explaining short-term rates.
A New Reserves Regime? COVID-19 and the Federal Reserve Balance Sheet
Aggregate reserves declined from nearly $3 trillion in August 2014 to $1.4 trillion in mid-September 2019, as the Federal Reserve normalized its balance sheet. This decline came to a halt in September 2019 when the Federal Reserve responded to turmoil in short-term money markets, with reserves fluctuating around $1.6 trillion in the early months of 2020. Then, in response to the COVID-19 pandemic, the Federal Reserve dramatically expanded its balance sheet, both directly, through outright purchases and repurchase agreements, and indirectly, as a consequence of the facilities to support market functioning and the flow of credit to the real economy. In this post, we characterize the increase in reserves between March and June 2020, describing changes to the distribution and concentration of reserves.
How the Fed Managed the Treasury Yield Curve in the 1940s
The coronavirus pandemic has prompted the Federal Reserve to pledge to purchase Treasury securities and agency mortgage-backed securities in the amount needed to support the smooth market functioning and effective transmission of monetary policy to the economy. But some market participants have questioned whether something more might not be required, including possibly some form of direct yield curve control. In the first half of the 1940s the Federal Open Market Committee (FOMC) sought to manage the level and shape of the Treasury yield curve. In this post, we examine what can be learned from the FOMC’s efforts of seventy-five years ago.
From Policy Rates to Market Rates—Untangling the U.S. Dollar Funding Market
How do changes in the rate that the Federal Reserve pays on reserves held by depository institutions affect rates in money markets in which the Fed does not participate? Through which channels do changes in the so-called administered rates reach rates in onshore and offshore U.S. dollar money markets? In this post, we answer these questions with the help of an interactive map that guides us through the web of interconnected relationships between the Fed, key market players, and the various instruments in the U.S. dollar funding market, highlighting the linkages across the short-term financial products that form this market.