Federal Reserve to begin test running new Term Deposit Facility (TDF)

Just this morning, the Federal Reserve Board of Governors announced that they will begin test running the new Term Deposit Facility, which was created in a final rule back in June of 2010 (link). This rule amended the Fed's Regulation D to allow for the auction of these new term deposits. I'm not entirely sure if this was the Fed's own initiative, or if it was a new authority granted the Financial Services Regulatory Relief Act of 2006, or some GFC related statute.

So now, in addition to paying interest on excess reserves through the new Excess Balance Accounts, the Fed  has another tool at its disposal to maintain a non-zero interest rate, without selling Treasury securities in open market operations. In other words, its now possible for the Fed to do QE-Infinity, buy up all the Treasury Securities on the market, and still maintain an overnight interest rate above zero. This new term deposit facility is basically just the Fed selling its own short term Certificates of Deposit (CDs), in order to provide an interest bearing alternatives to plain reserve balances. To be clear, these new term deposits do not satisfy an institution's required reserve balance or clearing balance and do not constitute excess balances. They are not available to clear payments and cant be used to reduce daylight or overnight overdrafts. 

According to the Fed, 

Term deposits may be awarded through a competitive single-price auction format with a non-competitive bidding option, a fixed-rate format at the interest rate specified in advance, or a floating-rate format. The interest rate paid on term deposits awarded through a floating-rate format will be the operation effective interest rate, which is determined by the average of the daily effective rates over the term of the instrument. 

However, just as with the interest-bearing Excess Balance accounts, Fannie, Freddie, and the Federal Home Loan Banks are not  eligible for this program. This means that they will continue to trade in the Federal Funds Market, which is why the effective Federal Funds Rate remains below the 25 basis points payed on excess reserve balances.As an aside, in the text of the final rule establishing the Excess Balance accounts, the Fed refers to un-remunerated reserve requirements as a "tax", just as Warren Mosler has.

I see this new facility as a modernization of monetary policy, which should make all the operations simpler to execute, and more importantly, easier for the general public to understand. Most people understand how CDs work, and these TDF are similar. For that reason, hopefully this test run will be successful, and will help us MMTers make our points, especially since Professor Scott Fullwiler has written extensively on these new advancements.

More information is available here. 

So can we please stop selling Treasury debt now? Its 2014 for Eccles' sake!

Slide Deck: MMT Knows- the Fed Sets Rates

I've been working on a powerpoint presentation laying out some MMT basics. Ideally, it could be presented to members of Congress and staffers to help them better understand our modern system of public finance. Link here

Federal Reserve Accounts for Government Securities at "Face Value"

Interesting disclosure in the footnotes to the Fed's H.4.1 report titled "Factors Affecting Reserve Balances" which some colloquially refer to as the Fed's "Balance Sheet".

The Treasury and Agency securities that the Fed holds and corresponding footnotes read:

Securities held outright (1) 2,630,907 + 12,108 + 13,312 2,668,891
 U.S. Treasury securities 1,661,520 + 5,631 - 10,011 1,660,807
 Bills (2) 0 0 - 18,423 0
 Notes and bonds, nominal (2) 1,577,099 + 5,426 + 1,067 1,575,114
 Notes and bonds, inflation-indexed (2) 73,543 + 199 + 6,059 74,740
 Inflation compensation (3) 10,878 + 6 + 1,285 10,953
 Federal agency debt securities (2) 79,283 0 - 26,626 79,283
 Mortgage-backed securities (4) 890,104 + 6,477 + 49,950 928,801

The corresponding footnotes:

1. Includes securities lent to dealers under the overnight securities lending facility; refer to table 1A.
2. Face value of the securities.
3. Compensation that adjusts for the effect of inflation on the original face value of inflation-indexed securities.
4. Guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Current face value of the securities, which is the remaining principal balance of the underlying mortgages.

So the Fed carries these securities NOT at "Market Value" and NOT at "Par Value" but at "Face Value". It would also seem that this value is not necessarily the same as the amount that the Fed originally pays for the securities they buy with newly created reserve balances.

For instance, if the Fed pays 100.5 for a US Treasury security with a Face Value of 100, this disclosure makes me believe that they would "book" the securities at 100 on the H.4.1 report and then do an non-directly-related reserve drain of 0.5 in order to result in the Factors balancing out with the new system reserves of 100.

This is perhaps why the Fed seems to buy most recently issued securities in it's "QE" type of operations as those securities would be priced more closely to the Face Value and would require less reserve level adjustments in order to position these amounts on it's Factors report at Face Value, i.e. NOT "Prices Paid" or "Market Value".

See Note 4 in this document for further information.

When you hear loose talk from the morons based on the reasoning of "the Fed can't raise interest rates and remove reserves because the drop in value of their bonds will render them insolvent, their stuck... blah, blah, blah...", as usual don't listen to them. This is apparently NOT the "way it works".

The Fed can certainly raise interest rates at any time without any direct effect on the Factors. And they can concurrently reduce the Factors as well via the normally scheduled US Treasury redemptions and normal MBS prepayments, which to the Fed, effectively result in a "Reserve Drain".

These operations will not cause any negative effects on the Fed's so-called "Balance Sheet".

To the Fed, it's all about interest rate setting; reserve drains, and reserve adds.

That these 3 monetary activities don't have much to do with US macro-economic performance is another story...

Scott Fullwiler on central bank policy, strategy and tactics

Scott posted this comment in clarification at Credit Writedowns.

Scott Fullwiler
3 April 2012 at 17:07

this is a good post, Ed, but this debate is muddled by a lack of definition of terms. More specifically, in the policy sciences there is a distinction made between policy, strategy, and tactics. Similar distinctions are found in business/management literature. Applying this to central banking, it goes a bit like this:

Tactics–can the central bank directly target reserve balances, monetary base, etc. 

Strategy–what sort of rules/discretion balance does the central bank follow in adjusting the target it has set tactically. How often? How big of an adjustment each time? 

By what criteria?

Policy–How does the macroeconomy work and what role can or should the central bank play in stabilizing it?

The debate between Krugman/Keen once it got to issues related to the money multiplier and loanable funds was about tactics–can banks individually or collectively create loans without regard to deposits or reserve balances? This is closely linked to an understanding of what banks are/do and hence Krugman’s view that they didn’t need to be included since inserting them didn’t change how one should view the money multiplier or loanable funds models. This is where I jumped in, because Krugman in my view was completely wrong on these points.

But Krugman’s reply to me, and Rowe’s post, brought in strategy and policy–”the central bank must change the interest rate target by adjusting to events and expectations” which is about how the central bank should adjust its target (strategy) within the context of how the macroeconomy works and interacts with monetary policy (policy). This is a complete tangent and obfuscation of the point that was being discussed. It is not unimportant–to the contrary, obviously—but to throw it in at this point was not helpful.

The MMT view is that we need to understand how the tactics work to inform our strategy and even our understanding of how the economy works. Krugman tried to suggest understanding the tactics is irrelevant to these two. This is a very significant distinction between the approaches.

Further, in MMT, we keep these three (tactics, strategy, policy) separate when we discuss them. Neoclassicals generally don’t–so, when I say the central bank must set an interest rate target (tactics) but can move that target wherever it wants (the possibilities for strategy), Nick says no the cb must set a target that responds to the economy and thus must be endogenous (strategy in the context of view of macroeconomy). We end up talking past each other as I have not invoked yet at all how central banks “should” set strategy with regard to how the macroeconomy works. While we will disagree on the latter, in our view jumping to that without clarifying and setting a common language for tactics and strategy complicates the discussion unnecessarily.

 Note finally that the “short” vs. “medium” horizon distinction Nick makes isn’t at all the same as the tactics vs. strategy distinction. The central bank can change the interest rate target every day or even every minute (possiblities for strategy) but must still defend that target every day, every hour, and every minute (tactics).

Hope that makes some sense. And hopefully none of this is seen as a personal attack on Nick–I agree with you that Nick is one of the most stand-up guys in the blog world and one whose criticisms of my own views are to be taken seriously.

Best,

Scott

Limits on Fed purchases

Marris asked in the comments about limits on Fed purchases. Nick Rowe recently up up a guest post by JP Koning at Worthwhile Canadian Initiative on this. Interesting comments on the post there, too.

I thought it important enough for the purview of this blog to call attention to it here.

Read it at Worthwhile Canadian Initiative
The legal scope of Fed purchases
by J P Koning