Monday, July 7, 2014

Update on Term Deposit facility

Its been a few months since my earlier post discussing the Fed's new Term Deposit Facility. Since then, the scope of this program has grown significantly, with auctions growing from around $25 billion per week, to a massive $125 billion in last week's auction.

These term deposits are simply one-week CD's offered by the Fed. Participating depository institutions have their reserve accounts debited, and then re-credited 7 days later, plus the small, but free amount of interest. While each institution can only tender a maximum of $10 billion, the amount of participating institutions has more than doubled since March of this year-- from 27 to 58. Not surprisingly, this growth in participation follows the Fed's gradual raising of the rates it will pay, from 26 basis points in March, to 30bp just today. Not surprisingly, the 26bp auctions had fewer participants than the 29 bp auction, since many institutions likely figured that getting a one-basis point spread over what they receive on their excess balance accounts (25bp) was not worth the trouble. For now, the Fed has stated that 30 basis points will be the ceiling for this round of term deposit auctions, with the first 30bp auction set to go off today.



The size of this latest auction demonstrates the ease to which the Fed can drain reserves if it chooses to. It simply states the rate that it will pay on term deposits,  and accepts bids. Last week in a matter of hours, the Fed was able to drain $125 billion in reserves from the banking system, with no problems. It will be interesting to see how much higher the Fed may decide to pay on its Term Deposits, and how large these auctions may become as a result. Unfortunately, the Fed states on multiple TDF related pages that the auctions "are a matter of prudent planning and have no implications for the near-term conduct of monetary policy."

It remains to be seen if this statement holds true in the future, since it seems to me that these term deposits are an easier way of raising rates if the Fed needs to, as opposed to trying to sell off their securities portfolio and expose themselves to potential losses. From a political standpoint, it will certainly be easier to expand the TDF than to try and "unwind QE", as many analysts put it.

6 comments:

Matt Franko said...

"as opposed to trying to sell off their securities portfolio "

Justin imo they need the portfolio income to be able to pay the interest to the term depositors...at keast politically....

so they would never reduce the portfolio holdings/increase the rate to a level that does not at least leave the portfolio to yield an amount that enables them to pay the IOR and term deposits like these...

rsp,

Ralph Musgrave said...

A question I’ve never seen a good answer to: where does money for the interest for those CDs (and Treasuries) come from? If the Fed simply prints the money, then Warren Mosler’s claim that interest rate rises can be stimulatory may be valid. On the other hand if the money is knocked off the amount paid by the Fed to government at the end of the year, then effectively that interest comes out of the pockets of taxpayers, thus Warren is likely to be wrong, i.e. interest rate rises will probably be deflationary.

Kristjan said...

" A question I’ve never seen a good answer to: where does money for the interest for those CDs (and Treasuries) come from? If the Fed simply prints the money, then Warren Mosler’s claim that interest rate rises can be stimulatory may be valid. On the other hand if the money is knocked off the amount paid by the Fed to government at the end of the year, then effectively that interest comes out of the pockets of taxpayers, thus Warren is likely to be wrong, i.e. interest rate rises will probably be deflationary."

There is no such question for Warren, for this thought exercise he consolidates CB and Treasury.What happens after Fed profits are paid to Treasury is a different matter already. Fed profits don't fund government spending. :)

Dan Kervick said...

Interest paid by the Fed on term deposits or ordinary reserves does reduce the Fed's net income and thus also reduces the amount of money remitted by the Fed to the Treasury.

However, I doubt it has much of an inmpact on taxpayers. If Fed remittances shrink next year, for example, then that just means the deficit won't decline at the same pace it has been recently. Taxes won't increase unless Congress increases them. (Tax revenues might increase, of course, if growth is stronger than anticipated and incomes increase.)

Tom Hickey said...

I think Warren would say that Fed collection of interest on tsys and payment of profit resulting therefrom to Treasury functions as a tax. It's money that would have gone to non-government otherwise, so it reduces non-government net financial assets. Therefore, Warren sees QE as potentially disinflationary and contractive in an already disinflationary and contractive environment, whereas at least some of the money that would have gone to non-government would have been spent, and that would have been simulative. Of course, some of that interest incomes might also have been committed to tax payments.

Regardless of the disposition of the funds, less is available for saving and spending, when the government should be making space to pay down excessive debt and also providing for spending into the economy to stimulate consumption and consequent investment.

This is shown by the deficit being smaller than it would have been otherwise, at a time that the deficit should increase for a full employment budget.

So the stimulative policy that the Fed adopted was actually not because low rates didn't stimulate borrowing for investment, which in theory they are supposed to do, and it reduced spendable incomes.

Similarly, interest rate rises would have a potentially contractionary effect in making borrowing more costly but it would also have a stimulatory effect by adding more interest income, some of which would get spent. So something of a wash, depending on circumstances.

The Just Gatekeeper said...

Right, the Fed's profits after operating expenses, dividends, and paying the interest on excess reserves and term deposits ends up back in the Treasury's General Account. From a purely financial standpoint, its another tax as Warren says. The reason this acts as a mild tax on the economy is that the interest that the fed pays on excess reserves and term deposits (25-30bp) is MUCH lower than the several hundred that Fed earns/the private sector would be earning if the Fed had not bought all those Treasuries.

So all the out of paradigm morons get to cheer that the deficit is being reduced, while we are all being impoverished.