In remarks at the ECB Conference on Money Markets on November 7, New York Fed President John C. Williams discussed the frameworks and tools that central banks use to implement monetary policy. In particular, he talked about the Federal Reserve’s operational framework and balance sheet strategy, and he gave an update to the Fed’s transition to an ample level of reserves.
He said:
“The [Federal Open Market Committee’s] implementation framework combines an ample supply of reserves with facilities to maintain strong interest rate control and flexibility regarding changes in the size of its balance sheet. This operational framework has proven to be highly effective—and it continues to work as designed.”
“I am closely monitoring a variety of market indicators related to the fed funds market, repo market, and payments to help assess the state of reserve demand conditions.”
“Based on recent sustained repo market pressures and other growing signs of reserves moving from abundant to ample, I expect that it will not be long before we reach ample reserves.”
President Williams began his remarks by discussing the importance of monetary policy frameworks. He said there are two sets of tools that central banks use to supply reserves, which range from a low level, or “scarce,” to “ample” and “abundant.”
“Like that of other central banks,” President Williams said, “the Fed’s operational framework has evolved over time, reflecting its experience with large balance sheets since the global financial crisis.”
In January 2019, the Federal Open Market Committee (FOMC) adopted an ample reserves strategy. In its Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization, the FOMC defined this framework as one in which “control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve’s administered rates, and in which active management of the supply of reserves is not required.”
The FOMC uses the overnight reverse repo facility (ON RRP) to ensure interest rate control. The ON RRP, alongside the interest paid on reserve balances (IORB), helps set a floor for the federal funds rate and “has proven to be a very effective and flexible tool to support interest rate control to the downside,” President Williams said.
The Standing Repo Facility (SRF), introduced in 2021, “nicely complements the ON RRP by providing interest rate control to the upside,” President Williams said. “This combination of an ample supply of reserves and an SRF rate at the top of the target range reduces the day-to-day reliance on the facility except during periods of significant upward pressure on rates resulting from strong liquidity demand or market stress.”
“By ensuring that adequate liquidity will be available in a wide variety of circumstances, the SRF plays a critical role in capping temporary upward pressure on rates and assures markets of effective interest rate control and smooth market functioning,” he said. “I fully expect that the SRF will continue to be actively used in this way and contain upward pressures on money market rates.”
After the onset of the pandemic, the Fed responded quickly to restore market functioning, which caused reserves to rise well above ample. In June 2022, the Fed began the process of reducing the size of its balance sheet to transition toward an ample level of reserves. Since then, the Fed’s securities holdings have shrunk from a peak of about $8-1/2 trillion in 2022 to $6-1/4 trillion today, President Williams said.
At its October 29 meeting, the FOMC said it would conclude the reduction of its aggregate securities holdings on December 1. “This decision was based on clear market-based signs that we had met the test of reserves being somewhat above ample,” President Williams said.
“In particular, repo rates have increased relative to administered rates and have exhibited more volatility on certain days,” he said. “Accordingly, we have been seeing more frequent use of the SRF. And the effective federal funds rate has increased somewhat relative to the IORB after years of that spread being at a stable level. These developments were expected as the supply of reserves closed in on ample.”
President Williams said the next step for the FOMC will be to assess when the level of reserves has reached ample. “It will then be time to begin the process of gradual purchases of assets that will maintain an ample level of reserves as the Fed’s other liabilities grow and underlying demand for reserves increases over time,” he said. “Such reserve management purchases will represent the natural next stage of the implementation of the FOMC’s ample reserves strategy and in no way represent a change in the underlying stance of monetary policy.”
President Williams concluded by saying that he is closely monitoring a variety of market indicators, and that he expects it will not be long before reserves reach ample.
Judy DeHaven is an executive communications specialist at the New York Fed.
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.
