I have read a few times now that the Fed has provided a lot of cash in return for (on a temporary basis via repos) questionable assets. At the same time, they want to keep the money supply about the same to have Fed Funds remain where it is, and they do that by removing liquidity by selling their previously big Treasury holdings. Net result is they have exchanged their Treasurys for bad assets and liquidity seems to me at least to be the same. If their goal is a) give banks more liquidity, and b) keep money supply the same to keep fed funds effective rate the same, how is that possible? Thank you for any insight you can provide!
Just wanted to see if anyone had any questions, as I am very curious about this =]
well, didn’t they achieve their goal? their goals were: a) give BANKS more liquidity. when the fed bought their bad assets, banks got all this $$$ in return. this helps their liquidity situation. if fed stopped there though, money supply will obviously have increased, which would bring down the interest rate and fed doesn’t want that, because that defeats their purpose of existing (maintain stable prices and control inflation). so in order to prevent this from occurring, they will sell treasuries at the same time (which has the effect of decreasing money supply, as you know). so these two actions taken by the fed have a cancelling effect on money supply. but the bank has resolved their liquidity situation.
The Fed Funds rate isn’t low enough for you? The effective rate now is below 1%. In no time at all we’re going to get back to those crazy days of 2003 where you can get negative repo rates and everyone in the world will be creating free interest rate options by failing to deliver under repo agreements and all that other wacky stuff that happens when rates get this low.
JoeyDVivre Wrote: ------------------------------------------------------- > The Fed Funds rate isn’t low enough for you? The > effective rate now is below 1%. In no time at all > we’re going to get back to those crazy days of > 2003 where you can get negative repo rates and > everyone in the world will be creating free > interest rate options by failing to deliver under > repo agreements and all that other wacky stuff > that happens when rates get this low. i believe this was a hypothetical, theory question. i was merely trying to answer the question!
Thanks. I think my question is: after the Fed has given the banks $$, the Fed then sells Treasurys to take $$ back from the market to keep money supply even. That $$ ultimately will come out of banks’ deposits, which means that banks have lost the liquidity that they just gained. Seems like I am missing something here… it’s not like the Fed gives banks money and takes money from random people holding money. Those “random people” have money deposited in banks, which they effectively ask to be transferred to the Fed, which deprives the banks of money.
The Fed doesn’t give banks money. The Fed lends it to them, possibly. The Fed “sells” (actually, the reverse repo them) Treasuries if that is part of their open market operations aimed at increasing the Fed Funds rate, presumably to the target rate.
Appreciate the effort, but I still do not think my question is being answered (someone please let me know if I am just being dense). Let’s assume I understand basic mechanics of how Fed conducts open market operations. What I do not understand is media reports of the Fed providing liquidity (thus temporarily or permanently increasing money supply) WHILE SIMULTANEOUSLY SELLING TREASURYS. The former adds to monetary supply while the latter reduces money supply. The media has said that this is the intent, since they want to provide liquidity while keeping money supply the same. HOW IS THIS POSSIBLE?