Last week, the Federal Open Market Committee (FOMC) announced steps to support the implementation of monetary policy. The FOMC directed the New York Fed’s Open Market Trading Desk (the Desk) to purchase Treasury bills at least into the second quarter of next year to maintain reserve balances at or above the level that prevailed in early September. It also directed us to conduct repo operations at least through January.
The open market operations that were announced are technical measures and do not represent a change in the stance of policy, so I wanted to walk through what’s going on and what that means for us at the Desk. I also suggest reading New York Fed President John Williams’ remarks from yesterday that cover this announcement.
How does this announcement fit into the FOMC’s overall approach to carrying out monetary policy decisions?
The actions announced last week are consistent with the FOMC’s January 2019 statement on monetary policy implementation and the balance sheet, which said that the FOMC intends to implement monetary policy in a framework based on “an ample supply of reserves.” (As a reminder, reserves are a form of central bank money, or cash, used by banks to settle payments between each other.) Under this framework, control over the federal funds rate is achieved primarily through changes in the Fed’s administered rates (the rate of interest paid on excess reserves and the rate paid on overnight reverse repos), and active management of the supply of reserves is not required.
Over recent years, the Fed had been normalizing its balance sheet by gradually reducing its securities holdings, and with them, the supply of reserve balances in the banking system. Gradual growth of non-reserve liabilities, which are largely outside of the Fed’s direct control, also reduce the supply of reserve balances.
The FOMC said that after it concluded its securities reduction plans at the end of July, it would allow those persistent gradual increases in non-reserve liabilities to continue to contribute to gradual decreases in reserve balances. This action would slow the pace at which reserve balances declined to a level that the FOMC judged was consistent with efficient and effective implementation of monetary policy in this ample reserves regime. Among other details, the FOMC announced in March that once that point was reached, it would begin increasing its securities holdings again to maintain an appropriate level of reserves. To do that, it would need to increase holdings to keep pace with growth over time in the Fed’s non-reserve liabilities (such as currency growth). It would also need to maintain a buffer of reserves to allow for the normal day-to-day variation some of them (like the Treasury General Account) exhibit.
Last week’s announcement marks the FOMC’s decision to begin increasing securities again. As I mentioned, these are technical adjustments in how we implement monetary policy. They don’t in any way alter the FOMC’s actual stance of policy. Instead, the objective of securities purchases is clear: to maintain an ample supply of reserves. After all, we want enough reserves in the system so that the fed funds rate remains in the target range without needing to actively fine-tune the supply of reserves on a daily basis. An ample level will also support smooth and effective money market functioning and payments activity.
With that in mind, what is the “right” amount of reserves for efficient and effective monetary policy?
For now, the FOMC has directed the Desk to maintain a level of reserves at or above the level in early September. That level is roughly between $1.45 and $1.5 trillion, and it can be calculated by taking the weekly averages of the first two weeks of September in the Fed’s weekly H.4.1 data release.
However, there is no fixed number for the appropriate level of reserves in an ample reserves framework. The level the FOMC determines is appropriate for the time being may change as the demand for reserves changes. That could depend on how economic and financial conditions evolve or how banks’ business models change.
The Fed is continuously working to better understand the banking system’s demand for reserves and how it is evolving. We expect that the FOMC will adjust its judgment about the appropriate level of reserves as we continue to learn.
How will the Desk achieve an ample level of reserves?
As noted in the FOMC’s October 11 directive, the Desk has been instructed to purchase Treasury bills and conduct repo operations. Both of these operations will add reserves to the system.
Treasury Bills: The purchase of Treasury bills through “reserve management purchases,” will help maintain the level of reserves over time. As non-reserve liabilities grow, reserve balances decline. Without offsetting that effect through the purchase of Treasury securities, growth of those liabilities could make reserves scarce. Such scarcity would put upward pressure on the fed funds rate, and the Desk would need to provide liquidity through temporary open market operations to immediately offset those pressures. This sort of active fine-tuning to manage the supply of reserves should not be necessary in an ample reserves regime over time.
Repo Operations: The term and overnight repo operations aim to ensure that the supply of reserves remains ample and mitigates the risk of money market pressures that could adversely affect policy implementation while we are still working to increase reserve levels on a more permanent basis through reserves management purchases.
What will the reserve management purchases look like in practice?
We started reserve management purchases this week, and plan to purchase approximately $60 billion from mid-October through mid-November. Reserve management purchases are effectively permanent additions to the Fed’s securities portfolio (and therefore the supply of reserves).
We will continue conducting these purchases over a monthly period at least into the second quarter of next year to maintain over time ample reserve balances at or above the level that prevailed in early September. These purchases are with primary dealers through our FedTrade platform. These reserve management purchases are in addition to our ongoing reinvestment and rollover operations.
As I noted earlier, our reserve management purchases are expected to offset recent and expected growth in non-reserve liabilities (such as currency in circulation) and to maintain over time reserves at levels that will absorb normal variability in those liabilities (such as those caused by changes in the Treasury General Account) without the need for active management of the supply of reserves. The initial pace of Treasury bill purchases also takes into account market functioning considerations and allows for some adjustments around periods with sharp expected declines in reserves or liquidity conditions. The Desk will adjust the timing and amount of purchases as necessary in response to changes in any of these considerations.
Detailed information on the schedule for these purchases of Treasury bills will be posted online monthly, and will identify the operation type as either reserve management purchases or reinvestment purchases.
How is this different from the so-called “quantitative easing,” or QE, done during the financial crisis?
The reserve management purchases announced last week are not Quantitative Easing (QE). Consider the policy goals for conducting these purchases, compared to the QE conducted during the Global Financial Crisis.
The purchases that started this week represent a technical adjustment that are intended to offset the effects of increases in the Fed’s non-reserve liabilities, in order to maintain an ample supply of reserve balances. These purchases support trend balance sheet growth, similar to the way the Desk’s outright purchases of Treasuries did before the crisis (even though the nominal amounts needed to do that today are larger).
These purchases are not aimed at having an impact on financial conditions. Without them, the level of reserves would continue to fall below levels needed to operate in an ample reserves regime. The purchases are not associated with a change in the FOMC’s overall stance of monetary policy.
The goals for QE purchases during the crisis were entirely different. Those were large-scale purchases designed to provide further monetary policy accommodation by putting downward pressure on the level of longer-term interest rates. Those purchases were well in excess of what was needed to keep apace of balance sheet growth over time, and as a byproduct, led to significant increases in the level of bank reserves.
How will the repo operations work?
The FOMC has directed the Desk to conduct term and overnight repo operations at least through January of next year to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could impede monetary policy implementation.
We have been conducting repo operations since September 17, when volatility in money markets put upward pressure on money market rates and pushed the fed funds rate above the top of the FOMC’s target range. These operations have been effective in calming money markets and in maintaining the federal funds rate in the target range. The continuation of these operations through next January will ensure that liquidity is available through temporary open market operations while we build up an ample supply of reserves through our Treasury bill purchases.
Term repo operations will generally be conducted twice per week, and we announce detailed information on the schedule of term and overnight repos on our website.
What’s next, and what will the Desk be watching as it implements both the reserve management purchases and repo operations?
The Desk is continuously monitoring money market conditions and the banking system’s demand for reserves. Our goal in doing so is to ensure that our operations will meet the FOMC’s directive to maintain an ample supply of reserves over time, which for now, the FOMC has defined as a level at or above that which prevailed in early September 2019 and to maintain the fed funds rate within the target range.
These dynamics are important and complex. The Fed conducts outreach and surveys, analyzes transactional data, and regularly monitors markets to help guide our understanding of markets and accomplish this objective.
This article was originally published by the New York Fed on Medium.
The views expressed in this article are those of the contributing authors and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.