Thread by @GeorgeSelgin

Thread: That the Fed is "fine" with the recent, tremendous ON-RRP uptake is interesting, considering what its own experts had to say about this possibility back when the facility was introduced in 2015.

https://twitter.com/michaelsderby/status/1402289263299940356

What follows are some excerpts from that year's FRB working paper, "Overnight RRP Operations as a Monetary Policy Tool: SomeDesign Considerations": federalreserve.gov/econresdata/fe…

"A very large ON RRP facility" would mean "the expansion of the Federal Reserve’s intermediation in short-term funding markets, which—particularly if such a facility were permanently in place—could alter financial markets in unpredictable ways."

Furthermore, "a very rapid and unexpected expansion of ON RRP might exacerbate disruptive flight-to-quality flows during a period of financial stress and thus could undermine financial stability."

FOMC "participants expressed concerns that in times of financial stress, the facility’s counterparties could shift investments toward the facility and away from financial and nonfinancial corporations, possibly causing disruptions in funding that could magnify the stress”

"The extent of the potential secondary effects of an ON RRP facility likely would depend on both the size of the facility and its potential rate of expansion."

A permanent facility "could lead to atrophying of the private infrastructure that supports [short-term funding] markets. Partially in response to some of these concerns, the FOMC has made clear that an ON RRP facility is _not intended to be permanent_." (My emphasis.)

"The facility could affect the chance of a widespread run. ...once a run is underway, the availability of ON RRPs could allow greater flight-to-quality flows during a run and thus could exacerbate the run and its
effects."

"Without ON RRPs, opportunities to run may be constrained by a limited supply of risk-free assets, and greater demand for those assets is likely to push up their prices and make running more costly."

"By contrast, an ON RRP facility that elastically supplies a very safe asset and which has the potential to increase in size by very large amounts would provide no immediate mechanism to slow a run."

"Cash that, in the absence of ON RRPs, might have moved quickly to liquid deposits at banks could go instead into a risk-free ON RRP facility through, for example, government MMFs that invest in ON RRPs."

" The sources of flight-to-quality flows, such as prime MMFs, could experience larger outflows than in past episodes, and the availability of short-term funding for broker-dealer and nonfinancial firms through vehicles like repo and CP could decline more quickly."

"An increase in ON RRP, which absorbs cash from the private sector, has very different implications for the availability of liquidity and credit in the economy than the classic central-bank tools that augment liquidity in periods of stress."

"In contrast to classic central-bank liquidity provision, which creates reserves, increased ON RRP take-up diminishes reserves."

"For these and other reasons, it may be prudent to design an ON RRP facility with features that would mitigate the risk of sharp, potentially disruptive surges of ON RRP take-up, while preserving the facility’s usefulness in helping to control short-term interest rates."

The authors go on to consider steps that could limit the risks in question: making the ON RRP facility temporary, changes in the ON RRP rate, quantity controls, and combinations of rate changes and quantity controls. None of these safeguards is presently in place.

I suppose Fed officials must have good reasons for believing that major risks identified by Fed staff in 2015 no longer exist today. But I for one would sleep a lot better if they'd share them with us!

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