How to Fire a Death Star

From the Fed:

The Fed staff "outlined several approaches to raising short-term interest rates when it becomes appropriate to do so, and to controlling the level of short-term interest rates once they are above the effective lower bound, during a period when the Federal Reserve will have a very large balance sheet," the minutes disclose.

"The approaches differed in terms of the combination of policy tools that might be used to accomplish those objectives," the minutes further report.

Among the policy tools that were discussed was the rate of interest paid on excess reserve balances, fixed-rate overnight reverse repurchase operations, term reverse repurchase agreements and the Term Deposit Facility (TDF).

The minutes say the staff presentation "discussed the potential implications of each approach for financial intermediation and financial markets, including the federal funds market, and the possible implications for financial stability." And the staff suggested options for additional operational testing of those tools.

New York Fed President and FOMC Vice Chairman William Dudley said Tuesday that his goal "to clarify our intentions later this year, long before we begin to contemplate raising short-term rates."

The minutes suggest a high degree of confidence that the various tools, in some combination "will allow (the Fed) to reduce policy accommodation when doing so becomes appropriate."

But they also suggest that the tools would have to be used with a certain amount of finesse and flexibility.
"Because the Federal Reserve has not previously tightened the stance of policy while holding a large balance sheet, most participants judged that the Committee should consider a range of options and be prepared to adjust the mix of its policy tools as warranted," the minutes continue.

"Participants generally favored the further testing of various tools, including the TDF, to better assess their operational readiness and effectiveness," the minutes add.
The original focus of "flooring" the short rate from shadow banking flooding the Fed Funds market has morphed into something more significant. The realization that the "floor" may need to be above the floor. Recent "communications" from the OMD suggest a "feel around" as to how to ensure the wide counter-party list actively engages the Death Star when needed. A rate equal to IOER MAY not be enough. Calling around and suggesting one play along is the first step. When adding in the TDF, a benign system of large and wide intermediation with the Fed emerges. The activity has no multiplier effect nor economic consequence.

The testing, discussing and white papering of conducting monetary policy with a large CB balance sheet is bureaucratic navel gazing run wild. IOER is a policy attached to CBs with "issues" to begin with. Concern about spread gaps could be lessened by cutting IOER toward the prevailing D-Star, FF and GC rates. Term Eurodollar deposits have been under constant downward pressure showing money is unwanted and un-needed. What the minutes showed is the FOMC is all about keeping the biggest clumsiest player in the market from banging into everything when he leaves the party.


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