Tags: federal reserve | potter | stimulus exit | learning process

Fed's Potter: Stimulus Exit Will Be Ongoing Learning Process

Thursday, 25 Sep 2014 02:19 AM

The Federal Reserve’s exit from the largest monetary stimulus campaign in the central bank’s history will be an ongoing learning process, according to a top New York Fed official.

“The framework for implementing monetary policy and the landscape in which we operate have seen important changes in the years since the crisis, and they continue to evolve,” said New York Fed Executive Vice President Simon Potter in a speech at the Japan Center for Economic Research in Tokyo.

“The operating tools that the Federal Reserve has developed will allow us to tighten monetary policy when the FOMC determines it is appropriate to do so, but I have no doubt that we will continue to learn more about how these tools interact as we normalize policy and make adjustments over time,” said Potter, who oversees the reserve bank’s Markets Group responsible for implementation of Fed monetary policy.

The Fed last week opened the door to sustaining a multi- trillion dollar bond portfolio for years, releasing new guidelines for how it would tighten policy for the first time since 2006. The decision cemented the central bank’s need to rely on additional tools to orchestrate its exit from near-zero interest rates because the usefulness of its benchmark federal funds rate in influencing credit conditions has been diminished by the flood of excess bank reserves it has pumped into the financial system through bond purchases.

Main Lever

The main lever the Fed will use to tighten is the interest rate that it pays banks on excess reserves. This will be backed up by overnight reverse repurchase agreements, which are designed to put a floor under interest rates. In a reverse repo transaction, the Fed borrows cash from market participants overnight at a specified rate, paying back counterparties, which are mostly money-market mutual funds, the next day.

Following last week’s Federal Open Market Committee meeting, the central bank capped the size of its overnight reverse repurchase facility, effective Sept 22. The new $300- billion-per-day limit on what the Fed will offer to borrow through reverse repos, which has been exceeded before, would, if breached, force market participants to lend cash overnight at rates below what the Fed offers.

“The Federal Reserve will be closely analyzing the results of the ON RRP exercise conducted under these new testing parameters in order to further its understanding of how an ON RRP facility might best be structured during the initial stages of the normalization process,” Potter said.

Prior to the introduction of the cap, the Fed’s reverse repo tests showed the facility could provide an effective floor under short-term interest rates. Until this week, a key measure of repo market rates calculated by the Depository Trust and Clearing Corporation had not traded below the Fed’s overnight reverse repo rate since Feb. 26, when the New York Fed increased it to 0.05 percent.

On Sept. 22, the DTCC measure fell to 0.047 percent, though the Fed only borrowed $178.3 billion through reverse repos, well beneath the new limit. Wednesday the rate rose to 0.058 percent.

 

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Economy
The Federal Reserve's exit from the largest monetary stimulus campaign in the central bank's history will be an ongoing learning process, according to a top New York Fed official."The framework for implementing monetary policy and the landscape in which we operate have seen...
federal reserve, potter, stimulus exit, learning process
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2014-19-25
Thursday, 25 Sep 2014 02:19 AM
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