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Conjoncture // December 2018
economic-research.bnpparibas.com
Simon Potter, Executive Vice President of the Federal Reserve Bank of
New York, recently indicated that for the time being there are no visible
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signs of an insufficiency of reserves at the aggregate level . Since the
Variations in central bank deposits are to an extent exogenous, a
function of monetary policy and the financial behaviour of non-bank
agents. We will examine the various non-conventional measures used
by the Fed over the last few years. First, the Fed’s securities purchasing
programme increased aggregate bank reserves (1.1), before the full
reinvestment of maturing debt stabilised them (1.2). Later, repo
transactions (1.3) and finally the ending of the full reinvestment of
beginning of the year the interest rate at which central bank deposits
have traded (the Effective Federal Funds Rate or EFFR) has certainly
risen, taking it close to the Interest on Excess Reserves (IOER) rate.
This increase has not, however, resulted from an increase in demand
for Fed Funds so much as additional issuance of Treasury bills, which
has pushed traditional lenders of Fed Funds (the Federal Home Loan
Banks) towards the repo markets. According to Potter, evidence of a
scarcity of central bank liquidity will only be manifested when there is a
significant increase in lending at above IOER rates on the unsecured
overnight markets, or when there is a clearer day-to-day relationship
between shifts in the IOER-EFFR spread and in the stock of reserves.
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maturing debt (1.4) began to reduce aggregate reserves .
The effects. The Fed’s quantitative easing (QE) policy from December
On the scale of the banking system as a whole, trends in central bank
reserves are exogenous, a function both of monetary policy decisions
and of portfolio choices in the non-bank sector (1 part). Over the past
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008 to October 2014 consisted of three waves of securities purchases
(
US Treasury debt, agency debt securities and mortgage backed
rst
securities – MBS – issued by the Fannie Mae and Freddie Mac
mortgage guarantee agencies ). This resulted in an expansion of the
ten years, the Federal Reserve has adjusted its supply of reserves
through a range of non-conventional means. The first such resulted in a
considerable increase in supply, with subsequent measures serving to
stabilise and then restrict it. On the margin of monetary policy, the
financial behaviour of non-bank agents has resulted in an increase in
the money circulating in the economy and in deposits from the Treasury
and foreign central banks held at the Fed. Overall, the aggregate
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central bank’s balance sheet both in its securities portfolio (on the asset
side) and reserve balances of depository institutions (on the liability side,
Chart 1). Banks’ reserves at the Fed thus moved into a significant
surplus relative to required reserves (the minimum levels in monetary
policy terms). Domestic banks acted as intermediaries for their clients in
QE, with the result that these purchases also contributed to a sharp
increase in deposits on the liabilities side of bank balance sheets13.
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availability of reserves has now been reduced as a result .
The issue of the ‘necessary’ level of reserves is not simple at first sight.
The LCR constraint was introduced in 2015 against a background of
abundant central bank liquidity, which therefore naturally represented a
substantial proportion of portfolios of liquid assets. In the third quarter of
The mechanics. If the banks themselves had sold their securities
portfolios, QE would simply have resulted in a substitution of assets on
their balance sheets (securities against reserves at the Fed), with no net
effect on the size of their balance sheets (Example 1, Figure 1 p.20).
However, between the end of the third quarter of 2008 and the fourth
quarter of 2014, it was mainly US ‘households’ (the household sector
includes hedge funds and private equity funds in US statistics), states
and local government, non-bank financial institutions (notably the GSEs,
2018, after four years of contraction in aggregate reserves, central bank
liquidity still accounted for more than 40%, on average, of liquid assets
under LCR of the eight biggest US banks (2nd part). The adjustment
strategies adopted since 2015 (substitution of liquid securities for
reserves, reduction in the use of short-term market debt) have, so far,
helped offset part of the reduced availability of reserves. Analysis also
shows that American banks are receiving increasing levels of support
from the Federal Home Loan Banks. Although it is hard to say whether
or not reserves are still ‘sufficient’, it does appear that we are seeing the
first signs of pressure on liquidity, albeit outside the Fed Funds market,
which runs contrary to the expectations of monetary authorities.
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See also J. Ihrig, L. Mize and G. Weinbach (2017), How does the Fed adjust
its securities holdings and who is affected?, Finance and Economics Discussion
Series, Divisions of Research & Statistics and Monetary Affairs, Federal
Reserve Board, and D. Leonard, A. Martin and S. Potter (2017), How the Fed
changes the size of its balance sheet, Liberty Street Economics, July 2017.
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Fannie Mae and Freddie Mac are the two big Government-Sponsored
Enterprises (GSEs) placed under the protection of the US Treasury since
September 2008. C. Choulet., The fate of Fannie Mae and Freddie Mac is not
yet sealed, BNP Paribas, Conjoncture 18-03, March 2018.
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S. Potter, US Monetary Policy Normalization is proceeding smoothly, Remarks
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at Banque de France, October 2018:
In a previous article we analysed the various reasons why domestic banks
https://www.newyorkfed.org/newsevents/speeches/2018/pot181026
The ability of banks to protect their liquidity ratios is diminished all the more
as the reduction in the Fed’s balance sheet comes against a background of
rising rates. The current increase in long-term interest rates depresses the value
of securities held on bank balance sheets (notably Treasuries), and thus the
value of the stock of liquid assets.
(US-chartered banks and US branches of foreign banks) modified the ‘natural’
effect of QE on their balance sheet, resulting in a shift in the ownership structure
of reserves with the Fed with no equivalent distortion of the structure of
customer deposits on the liabilities side of their balance sheets. C. Choulet., QE
and bank balance sheets: the American experience, BNP Paribas, Conjoncture
15-07, July-August 2015.
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