## 1. Fed Funds Policy Rate and General Collateral, Pre‑Lehman vs. Present

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---

### Introduction and context
- Many recent studies focus on tools available to the Federal Reserve (Fed) for liftoff—the gradual increase in its policy rate after several years of keeping it at zero.
- Limited discussion exists about the financial plumbing connecting bank and nonbank balance sheets and changes stemming from proposed regulations such as the leverage ratio and the liquidity coverage ratio (LCR).
- Core argument: liftoff and monetary policy will need to address the reshuffling of the bank/nonbank nexus created by the Fed’s large-scale asset purchases and its increasing direct dealings with nonbanks.

### Key features of post‑crisis markets and rates
- Interest rates in most relevant short-term markets lie in the range of zero and 25 basis points.
- The Federal Funds (FF) rate or policy rate has been around 10–15 bps since the crisis and is largely a negotiated rate stemming from excess cash balances of nonbanks (e.g., GSEs) and banks.
- Only banks have access to the 25 basis points interest on excess reserves (IOER).
- The Fed introduced the overnight reverse repo program (ON RRP) in Sept 2013 to prevent repo rates from going below zero and to minimize the wedge with the policy rate.
- The ON RRP is capped at $300 billion and has provided an effective floor to the repo rate at 3–5 bps.
- Pre‑Lehman, the FF rate was within +/-3 basis points of the General Collateral (GC) rate except for quarterly‑ending dates that straddle inventory, regulatory, and reporting aspects.

### Liftoff considerations (FOMC/minutes and Fed speeches)
- Policymakers will be particularly careful at the start of liftoff because demonstrating appropriate control over the federal funds rate and other short-term rates is a priority.
- The ON RRP may require elevated aggregate capacity at liftoff because demand for ON RRPs and the support previously provided by the zero lower bound are uncertain.
- The ON RRP is to be used only to the extent necessary for monetary policy control given its potential financial stability and footprint costs.

### The Fed’s balance sheet, RRP, and excess reserves
- The Fed’s balance sheet increased from roughly $1 trillion (end-2007) to over $4 trillion by end-2014 owing mainly to some $3.4 trillion of asset purchases that sit on its asset side.
- Corresponding entry on the liabilities side is excess reserves of $2.9 trillion—these are deposits of nonbanks (who sold assets to the Fed) at banks, which then place them as deposits at the Fed.
- Since October 2008, the Fed offers banks 25 basis points per annum for their deposits (including excess deposits over the required reserves) but pays zero interest on deposits from nonbanks, especially GSEs.
- A decline in excess reserves does not necessarily result in a reduction of the Fed’s balance sheet.
- Example statistics as of April 22, 2014:
  - Total U.S. Treasuries and MBS held by the Fed were $4.2 trillion, of which $750 billion were held as of end-2007.
  - Excess Reserves as per April 22, 2014 were $2.9 trillion, basically all of which was added after end-2007.
- FDIC data cited:
  - Top 50 bank holding companies held $7 trillion of deposits as of June 30, 2014, relative to $4 trillion as of June 30, 2008.
  - The top four bank holding companies held about $3.8 trillion in deposits as per June 30, 2014 data, relative to $1.9 trillion as of June 30, 2008.

### Operational constraints of the RRP and Triparty system
- RRP collateral reuse restricted: collateral can only be used in a Triparty repo liability.
- Members of the Government Securities Division (GSD) of the DTCC can reuse collateral within the General Collateral Finance (GCF) Triparty system only.
- Within the present Triparty structure:
  - Collateral from the Fed’s RRP cannot be used to post at central clearinghouses, in the bilateral derivatives markets, in the bilateral repo market, or delivered against short positions.
  - There exists a sizable pledged collateral market that is not constrained by the Triparty structure.
- Only firms that take Triparty repo liabilities can integrate RRP collateral into Triparty liabilities; collateral released from the RRP remains an asset on the Fed’s balance sheet and within the Triparty system.

### Nonbanks’ use of the Reverse Repo Program (RRP) — accounting and balance sheet implications
- Present ON RRP operational caps:
  - ON RRP is capped at $300 billion.
  - Cap of $30 billion per counterparty per transaction.
- Even if bids for RRP were uncapped, the collateral of the RRP would remain on the Fed’s balance sheet and not freely available to the financial system.
- The RRP functions as more akin to “accounting drainage” because the $3.4 trillion of assets purchased remain on the Fed’s asset side; RRP only reshuffles line items on the liability side.
- Illustration: if the RRP’s ceiling were increased from $300 billion to $1.3 trillion:
  - Only the excess reserves will go down by $1 trillion; the corresponding entry will be on the liability side of the Fed balance sheet as “RRP with the Fed”.
- Operational effect on banks and nonbanks:
  - For each $100 million of RRP, typically a nonbank removes $100 million deposits from a bank and places it with the Fed.
  - The Fed becomes the new counterparty to the nonbank, while the bank gains “balance sheet space” as the $100 million deposits move from a bank to the Fed.
- Distinction:
  - Selling assets from the Fed’s balance sheet to shrink the balance sheet differs from reshuffling Fed liabilities between line items (e.g., excess reserves and RRP). Rearranging liabilities changes others’ balance sheets at every stage; selling assets allows those assets to move to their final holder.

### Major implications for monetary policy at liftoff
- Monetary policy during liftoff must address the new financial plumbing created by sizable asset purchases, including:
  - Managing the “excess” depository market with money funds.
  - Recognizing the increased demand for high‑quality collateral stemming from proposed regulations.
  - Accounting for balance sheet cost as excess reserves are included in the supplementary leverage ratio (SLR) in the U.S.
- The GC rate is a reliable proxy for bilateral repo rates only when the market plumbing works; at liftoff it will be important that the FF rate be broadly in line with the GC rate as was the case pre‑Lehman.

### Box 1 — The Financial Plumbing: Pledged Collateral that can be Reused by Global Banks

- Overview and key metrics:
  - “Fair value of securities received as collateral that is permitted to be sold or re-pledged” by global banks:
    - approximately $10 trillion in 2007
    - about $6 trillion in recent years (end-2014)
  - Collateral reuse rate (collateral velocity):
    - declined from about three as of end-2007 to about two as of end-2014
  - Collateral types:
    - bonds or equities (pledged at mark-to-market values)
    - legally cash-equivalent via title transfer; do not have to be AAA/AA rated
  - Largest suppliers of pledged collateral:
    - hedge funds; other suppliers include insurers, pension funds, central banks, sovereign wealth funds

- Mechanics of the bilateral pledged collateral market ("financial plumbing"):
  - Financial agents that settle daily margins post cash or securities, choosing the “cheapest to deliver.”
  - Securities received by bank collateral desks come via reverse-repo, securities borrowing, prime brokerage agreements, and OTC derivative positions.
  - Economics of pledged collateral reuse is similar to reuse of deposits in the banking system.
  - Central banks should monitor collateral reuse rate alongside money metrics to gauge the short-term rate environment.

- Liftoff scenarios: implications for GC and FF rates
  - Context:
    - Example liftoff: Fed Funds target moves from current level of 10–15 basis points to 25–50 basis points.
    - “Good collateral” such as U.S. Treasuries in market hands = x trillion; about 80–85 percent of some bonds are parked with central banks, SWFs, insurers, and pension funds.
    - Present reuse rate around two (end-2014), down from about three (end-2007).
  - Route 1 — Large RRP drains money primarily from nonbanks:
    - With a large RRP and unchanged market-domain collateral (x trillion):
      - money moves to the Fed balance sheet, market has less money relative to collateral
      - GC rate will be pushed up by market forces
      - repo curve (price of money for given collateral and tenor) is downward sloping; money curve is upward sloping
    - Market plumbing effects:
      - bilateral pledged collateral market becomes illiquid as money moves to Fed balance sheet
      - reduces demand for collateral from hedge funds and other collateral suppliers
      - dealer banks return Treasuries and agency MBS to securities-lenders and give back securities to hedge funds/REITs due to reduced funding from money pools
      - cost of funding long positions for non-dealers increases; demand for and price of securities declines; value of Fed assets falls whether Fed sells them or does a large RRP
    - Example figures and caps:
      - present RRP cap is $300 billion
      - stylized scenario shown for RRP with non-bank at $1.3 trillion (illustrative)
  - Route 2 — Fed sells U.S. Treasuries to market:
    - Increases collateral in market domain; collateral reuse rate (exogenous to Fed) may cause GC rate not to coincide exactly with FF rate
    - Controlled sales can help align GC and FF
    - Sales of $100 million U.S. Treasuries can release effectively more than $100 million in collateral depending on the reuse rate (around two presently)
    - If Fed sells Treasuries, nonbanks withdraw deposits from banks to purchase Treasuries; banks gain balance sheet space
    - Asset sales do not “rust” plumbing as a large RRP would; large global banks prefer asset sales to avoid rusting plumbing
  - Policy-technical tradeoff summary:
    - Fed can reach liftoff objectives with minimal footprint on plumbing via asset sales; under that modality GC is a market rate and plumbing remains functional
    - Large RRP increases Fed footprint, weakens market signals, and “rusts” plumbing

- Collateral characteristics affecting reuse (distinct from “moneyness”):
  - (a) acceptability to counterparties
  - (b) ease of use—likelihood of becoming special; amount floating around
  - (c) price volatility (frequency of posting margins)
- Preferred securities by these metrics:
  - T-bills accepted most broadly but require frequent replacement
  - “Sweet spot”: bills or short coupon securities with 6 months to 2 years to maturity (widely accepted, easiest to deal with)
  - Next in demand: 2–5 year notes, then longer notes (up to 10 years), then shorter bills, then longer tenor bonds (over 10 years)
  - Good collateral like U.S. Treasuries incentivizes reuse of other lower-quality collateral because collateral is exchanged as portfolios

- Shortage of safe assets — should the Fed help?
  - Demand = Supply * re-use rate
  - Increasing supply of safe assets may be achieved by increasing reuse rate rather than only issuing more.
  - Large stocks of U.S. “good collateral” are parked with custodians/central banks/insurers/pension funds and not reused (zero velocity).
  - Two-thirds of U.S. Treasuries outstanding are held by “rest of the world”.
  - RRP rate during liftoff likely higher than present 5 bps; issuing short tenor T-bills may be cheaper (short tenors presently near zero).
  - Even if financial stability arguments support supplying HQLA via RRP, lower issuance cost of T-bills in a rising rate environment constrains RRP expansion.
  - A large RRP would be orthogonal to proposed 2016 regulations requiring prime MMMFs to maintain a floating NAV.

- Monetary policy transmission and implications for central banks
  - Many money and repo rates in the U.S. have been between zero and 25 basis points in recent years; alignment of short-term rates matters as liftoff approaches.
  - Financial plumbing connecting bank and nonbank balance sheets has been altered by proposed regulations (leverage ratio, LCR) and by asset purchases.
  - A well-functioning market plumbing is useful to extract market signals (e.g., GC rate) and should not be compromised.
  - If the Fed increases its footprint on market plumbing (large RRP), market signals weaken and correlation between policy rate (FF) and other short-term rates (GC) may fall, potentially compromising monetary policy transmission.
  - After liftoff, FF and GC rates need to move together for effective transmission.
  - Following Fed asset purchases that withdrew good collateral from market, the paper argues for asset sales by the Fed to lubricate plumbing and increase collateral re-use rate.
  - Coordination with Treasury on debt issuance will be useful; there is no obligation for Fed or Treasury to supply safe assets under monetary policy rubric at higher cost than warranted.

*Source: IMF working paper section "1. Fed Funds Policy Rate and General Collateral, Pre‑Lehman vs. Present" (excerpts provided).*

### 1. Fed Funds Policy Rate and General Collateral, Pre-Lehman vs. Present ..............................5

### 1. Fed Funds Policy Rate and General Collateral, Pre-Lehman vs. Present

### Introduction and context
- Many recent studies focus on tools available to the Federal Reserve (Fed) for liftoff—the gradual increase in its policy rate after several years of keeping it at zero.
- The paper emphasizes limited discussion about the financial plumbing connecting bank and nonbank balance sheets and changes stemming from proposed regulations such as the leverage ratio and the liquidity coverage ratio (LCR).
- Core argument: liftoff and monetary policy will need to address the reshuffling of the bank/nonbank nexus created by the Fed’s large-scale asset purchases and its increasing direct dealings with nonbanks.

### Key features of post‑crisis markets and rates
- Interest rates in most relevant short-term markets lie in the range of zero and 25 basis points.
- The Federal Funds (FF) rate or policy rate has been around 10–15 bps since the crisis and is largely a negotiated rate stemming from excess cash balances of nonbanks (e.g., GSEs) and banks.
- Only banks have access to the 25 basis points interest on excess reserves (IOER).
- With interest rates bound at zero since 2008, the Fed introduced the overnight reverse repo program (ON RRP) in Sept 2013 to prevent repo rates from going below zero and to minimize the wedge with the policy rate.
- The ON RRP is capped at $300 billion and has provided an effective floor to the repo rate at 3–5 bps.
- Pre‑Lehman, the FF rate was within +/-3 basis points of the General Collateral (GC) rate except for quarterly‑ending dates that straddle inventory, regulatory, and reporting aspects.

### Liftoff considerations (from FOMC/minutes and Fed speeches)
- Policymakers will be particularly careful at the start of liftoff because demonstrating appropriate control over the federal funds rate and other short-term rates is a priority.
- The ON RRP may require elevated aggregate capacity at liftoff because demand for ON RRPs and the support previously provided by the zero lower bound are uncertain.
- The ON RRP is to be used only to the extent necessary for monetary policy control given its potential financial stability and footprint costs.

### Paper focus and organization
- The paper focuses on the repo markets and the bank deposits market as critical pieces of the plumbing in the wake of liftoff.
- It argues monetary policy at liftoff must accommodate:
  - (i) the ‘‘excess’’ depository market with the money funds;
  - (ii) the demand for collateral stemming from proposed regulations;
  - (iii) the balance sheet cost (or balance sheet space) as excess reserves are included in the supplementary leverage ratio in the U.S.

---

### The Fed’s balance sheet, RRP, and excess reserves
- The Fed’s balance sheet increased from roughly $1 trillion (end-2007) to over $4 trillion by end-2014 owing mainly to some $3.4 trillion of asset purchases that sit on its asset side.
- The approximate corresponding entry on the liabilities side is excess reserves of $2.9 trillion—these are deposits of nonbanks (who sold assets to the Fed) at banks, which then place them as deposits at the Fed.
- Since October 2008, the Fed offers banks 25 basis points per annum for their deposits (including excess deposits over the required reserves) but pays zero interest on deposits from nonbanks, especially GSEs.
- A decline in excess reserves does not necessarily result in a reduction of the Fed’s balance sheet.
- Example statistics from April 22, 2014:
  - Total U.S. Treasuries and MBS held by the Fed were $4.2 trillion, of which $750 billion were held as of end-2007.
  - Excess Reserves as per April 22, 2014 were $2.9 trillion, basically all of which was added after end-2007.
- FDIC data cited:
  - Top 50 bank holding companies held $7 trillion of deposits as of June 30, 2014, relative to $4 trillion as of June 30, 2008.
  - The top four bank holding companies (Bank of America, Wells Fargo, Citibank and JPMorgan) held about $3.8 trillion in deposits as per June 30, 2014 data, relative to $1.9 trillion as of June 30, 2008.

### Operational constraints of the RRP and Triparty system
- The operational structure of the RRP facility puts practical restrictions on the reuse of collateral outside the Triparty system: collateral can only be used in a Triparty repo liability.
- Members of the Government Securities Division (GSD) of the Depository Trust and Clearing Corporation (DTCC) can reuse the collateral within the General Collateral Finance (GCF) Triparty system only.
- Within the present Triparty structure:
  - Collateral from the Fed’s RRP cannot be used to post at central clearinghouses, in the bilateral derivatives markets, in the bilateral repo market, or delivered against short positions.
  - There exists, however, a sizable pledged collateral market that is not constrained by the Triparty structure (see Box 1 in the source).
- Only firms that take Triparty repo liabilities can integrate RRP collateral into Triparty liabilities; collateral released from the RRP remains an asset on the Fed’s balance sheet and within the Triparty system.

### Nonbanks’ use of the Reverse Repo Program (RRP) — accounting and balance sheet implications
- Present ON RRP operational caps:
  - ON RRP is capped at $300 billion.
  - Cap of $30 billion per counterparty per transaction.
- Even if bids for RRP were uncapped, the collateral of the RRP would remain on the Fed’s balance sheet and not freely available to the financial system.
- The RRP functions as more akin to “accounting drainage” because the $3.4 trillion of assets purchased remain on the Fed’s asset side; RRP only reshuffles line items on the liability side.
- Illustration: if the RRP’s ceiling were increased from $300 billion to $1.3 trillion:
  - Only the excess reserves will go down by $1 trillion; the corresponding entry will be on the liability side of the Fed balance sheet as “RRP with the Fed”.
- Operational effect on banks and nonbanks:
  - For each $100 million of RRP, typically a nonbank removes $100 million deposits from a bank and places it with the Fed.
  - The Fed becomes the new counterparty to the nonbank, while the bank gains “balance sheet space” as the $100 million deposits move from a bank to the Fed.
- Distinction highlighted:
  - Selling assets from the Fed’s balance sheet to shrink the balance sheet differs from reshuffling Fed liabilities between line items (e.g., excess reserves and RRP). Rearranging liabilities changes others’ balance sheets at every stage; selling assets allows those assets to move to their final holder.

### Major implications for monetary policy at liftoff
- Monetary policy during liftoff must address the new financial plumbing created by sizable asset purchases, including:
  - Managing the “excess” depository market with money funds.
  - Recognizing the increased demand for high‑quality collateral stemming from proposed regulations.
  - Accounting for balance sheet cost as excess reserves are included in the supplementary leverage ratio (SLR) in the U.S.
- The GC rate is a reliable proxy for bilateral repo rates only when the market plumbing works; at liftoff it will be important that the FF rate be broadly in line with the GC rate as was the case pre‑Lehman.

*Source: IMF working paper section "1. Fed Funds Policy Rate and General Collateral, Pre‑Lehman vs. Present" (excerpts provided).*

### Box 1. The Financial Plumbing: Pledged Collateral that can be Reused by Global Banks

### Box 1. The Financial Plumbing: Pledged Collateral that can be Reused by Global Banks

### Overview and key metrics
- The “fair value of securities received as collateral that is permitted to be sold or re-pledged” by global banks:
  - approximately $10 trillion in 2007
  - about $6 trillion in recent years (end-2014)
- Collateral reuse rate (collateral velocity):
  - declined from about three as of end-2007 to about two as of end-2014
- Collateral types:
  - bonds or equities (pledged at mark-to-market values)
  - legally cash-equivalent via title transfer; do not have to be AAA/AA rated
- Largest suppliers of pledged collateral:
  - hedge funds; other suppliers include insurers, pension funds, central banks, sovereign wealth funds

### Mechanics of the bilateral pledged collateral market ("financial plumbing")
- Financial agents that settle daily margins post cash or securities, choosing the “cheapest to deliver.”
- Securities received by bank collateral desks come via reverse-repo, securities borrowing, prime brokerage agreements, and OTC derivative positions.
- Economics of pledged collateral reuse is similar to reuse of deposits in the banking system.
- Central banks should monitor collateral reuse rate alongside money metrics to gauge the short-term rate environment.

### Liftoff scenarios: implications for GC (general collateral) and FF (Fed Funds) rates
- Context:
  - Example liftoff: Fed Funds target moves from current level of 10–15 basis points to 25–50 basis points.
  - “Good collateral” such as U.S. Treasuries in market hands = x trillion; about 80–85 percent of some bonds are parked with central banks, SWFs, insurers, and pension funds.
  - Present reuse rate around two (end-2014), down from about three (end-2007).
- Route 1 — Large RRP (reverse repo) drains money primarily from nonbanks:
  - If RRP is sizable and targets draining, collateral in market domain remains unchanged at x trillion.
  - Money (FF) is the price of money; GC is the price of collateral. With a large RRP:
    - money moves to the Fed balance sheet, market has less money relative to collateral
    - GC rate will be pushed up by market forces
    - repo curve (price of money for given collateral and tenor) is downward sloping; money curve is upward sloping
  - Effects on market plumbing:
    - bilateral pledged collateral market becomes illiquid as money moves to Fed balance sheet
    - reduces demand for collateral from (i) hedge funds needing financing; (ii) other collateral suppliers seeking securities lending returns
    - dealer banks return Treasuries and agency MBS to securities-lenders and give back securities to hedge funds/REITs due to reduced funding from money pools
    - cost of funding long positions for non-dealers increases; demand for and price of securities declines; value of Fed assets falls whether Fed sells them or does a large RRP
  - Example figures and caps:
    - present RRP cap is $300 billion
    - stylized scenario shown for RRP with non-bank at $1.3 trillion (illustrative)
- Route 2 — Fed sells U.S. Treasuries to market:
  - Increases collateral in market domain; collateral reuse rate (exogenous to Fed) may cause GC rate not to coincide exactly with FF rate
  - Controlled sales can help align GC and FF
  - Sales of $100 million U.S. Treasuries can release effectively more than $100 million in collateral depending on the reuse rate (around two presently, from about three in 2007)
  - If Fed sells Treasuries, nonbanks withdraw deposits from banks to purchase Treasuries; banks gain balance sheet space
  - Asset sales do not “rust” plumbing as a large RRP would; large global banks prefer asset sales to avoid rusting plumbing
- Summary of policy-technical tradeoff:
  - Fed can reach liftoff objectives with minimal footprint on plumbing via asset sales; under that modality GC is a market rate and plumbing remains functional
  - Large RRP increases Fed footprint, weakens market signals, and “rusts” plumbing

### Illustrations and labels (figures referenced)
- Figures referenced in text illustrate:
  - pledged collateral received by U.S. banks (2007–14)
  - pledged collateral received by European banks and Nomura (2007–14)
  - Figure 4: Large RRP Program and Shifts in Money Curve (author’s estimates)
  - Figure 5: The New Plumbing: Large RRP and Rusting of the Plumbing (author’s illustration)
  - Figure 6: Asset Sales and No Change in Size of RRP (author’s illustration)
- Horizontal axes of Figures 4 and 6 labeled M (money) or CV (collateral x velocity) because Fed’s RRP exchanges money (M) and collateral (C) on a one-to-one basis; U.S. Treasury sales can do M:CV where V ≠ 1 (average velocity has been > 1)

### Box 2 — Demand for High Quality Liquid Assets (HQLA)
- Main points:
  - Demand for HQLA stemming from regulations is substitutable between banks and nonbanks.
  - Monetary policy tools such as RRP impact plumbing and reshuffle HQLA needs between banks and nonbanks.
  - Banks’ demand for RRP is negligible at present because reservation price is much higher than the 3–5 bps offered by RRP:
    - banks receive interest on excess reserves of 25 bps for their own funds, or around 5–15 bps via client’s funds after split with client and netting for FDIC fee
    - foreign banks exempt from FDIC fee are the most active in the RRP market
  - RRP rate currently acts as a non-market price floor preventing repo rates from going below zero
  - Present RRP cap of $300 billion is sufficient to meet demand from nonbanks (Annex 1 referenced)
  - Bilateral plumbing estimated at $6 trillion (end-2014), down from $10 trillion pre-crisis
- Stylized T-account scenario:
  - Large RRP at $1.3 trillion (illustrative) would reduce banks’ demand for HQLA as nonbanks withdraw deposits and increase positions in Fed’s RRP (substitution effect)
  - Market sources seeking a large RRP should note RRP is a monetary tool for liftoff and not a conduit to supply safe assets; expanding quantity or counterparties would increase Fed’s footprint and rust plumbing
- Collateral characteristics affecting reuse (distinct from “moneyness”):
  - (a) acceptability to counterparties
  - (b) ease of use—likelihood of becoming special; amount floating around
  - (c) price volatility (frequency of posting margins)
- Preferred securities by these metrics:
  - T-bills accepted most broadly but require frequent replacement
  - “Sweet spot”: bills or short coupon securities with 6 months to 2 years to maturity (widely accepted, easiest to deal with)
  - Next in demand: 2–5 year notes, then longer notes (up to 10 years), then shorter bills, then longer tenor bonds (over 10 years)
  - Good collateral like U.S. Treasuries incentivizes reuse of other lower-quality collateral because collateral is exchanged as portfolios

### Shortage of safe assets — should the Fed help?
- Historical context:
  - Before 1982, U.S. Treasury issuance was tactical and less predictable; since 1982 issuance became regular and at least-cost
  - Correlation between ratio of U.S. T-bills/total debt issuance and relevant funding costs is above 0.6 (Figure 7 referenced)
- Post-Lehman supply of safe assets changed; reuse rate matters:
  - Demand = Supply * re-use rate
  - Increasing supply of safe assets may be achieved by increasing reuse rate rather than only issuing more
  - Large stocks of U.S. “good collateral” are parked with custodians/central banks/insurers/pension funds and not reused (zero velocity)
  - Two-thirds of U.S. Treasuries outstanding are held by “rest of the world”; emerging markets generally less aggressive in reusing holdings
  - Safe assets should be supplied to market with ownership and possession enabling making a market and avoiding rusting plumbing
- Cost considerations:
  - RRP rate during liftoff likely higher than present 5 bps; issuing short tenor T-bills may be cheaper (short tenors presently near zero)
  - Even if financial stability arguments support supplying HQLA via RRP, lower issuance cost of T-bills in a rising rate environment constrains RRP expansion
  - A large RRP would be orthogonal to proposed 2016 regulations requiring prime MMMFs to maintain a floating NAV

### Monetary policy transmission and implications for central banks
- Many money and repo rates in the U.S. have been between zero and 25 basis points in recent years; alignment of short-term rates matters as liftoff approaches
- Key arguments:
  - Financial plumbing connecting bank and nonbank balance sheets has been altered by proposed regulations (leverage ratio, liquidity coverage ratio) and by asset purchases
  - A well-functioning market plumbing is useful to extract market signals (e.g., GC rate) and should not be compromised
  - If the Fed increases its footprint on market plumbing (large RRP), market signals weaken and correlation between policy rate (FF) and other short-term rates (GC) may fall, potentially compromising monetary policy transmission
  - After liftoff, FF and GC rates need to move together for effective transmission
  - In the aftermath of Fed asset purchases that withdrew good collateral from market, the paper argues for asset sales by the Fed to lubricate plumbing and increase collateral re-use rate
  - Coordination with Treasury on debt issuance will be useful; there is no obligation for Fed or Treasury to supply safe assets under monetary policy rubric at higher cost than warranted

*Source: Box 1 from _wp15202 - Box 1. The Financial Plumbing: Pledged Collateral that can be Reused by Global Banks*

### REFERENCES:

### _wp15202 - REFERENCES:

### Key References Cited
- Barnes, Michelle, 2014, “Let’s Talk About It: What Policy Tools Should the Fed Normally Use?” Federal Reserve Bank of Boston, Paper No 14–12. http://www.bostonfed.org/economic/current-policy-perspectives/2014/cpp1412.pdf
- Bernanke, Ben, 2015, “Monetary Policy in the Future,” IMF’s Rethinking Macro Policy III conference, April 15.
- Caballero, Ricardo, and Emmanuel Fahri, 2013, “A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy”, NBER Working Paper No:18737, August.
- Carpenter, Seth; Selva Demiralp, Jane Ihrig, and Elizabeth Klee (2013), “Analyzing Federal Reserve Asset Purchases: From Whom does the Fed buy?,” Finance and Economics Discussion Series Divisions of Research and Statistics and Monetary Affairs, Federal Reserve Board, No 2013–32.
- DTCC, “Economics of Collateral,” also under, London School of Economics Discussion Paper, (Anderson, R.W. and Karin Joeveer, 2014) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2427231
- Dudley, William, 2014, The Economic Outlook and Implications for Monetary Policy. Remarks before the New York Association for Business Economics, May 20. http://www.newyorkfed.org/newsevents/speeches/2014/dud140520.html
- Duffee, Gregory R., 1996, "Idiosyncratic Variation of Treasury Bill Yields," Journal of Finance, Vol. 51, No. 2, pp. 527---52.
- European Systemic Risk Board, 2014, An Analysis of the ESRB’s First Data Collection on Securities Financing Transactions and Collateral (re)use, Occasional Paper No. 6, September.
- Frost, Joshua, Lorie Logan, Antoine Martin, Patrick McCabe, Fabio Natalucci, and Julie Remache, 2015, “Overnight RRP Operations as a `Monetary Policy Tool: Some Design Considerations,” New York Fed Staff Report, Number 712, February, http://www.newyorkfed.org/research/staff_reports/sr712.html
- Gagnon, Joseph E, and Brian Sack, 2014, ‘‘Monetary Policy with Abundant Liquidity: A New Operating Framework for the Federal Reserve,’’ Peterson Institute of International Economics, Policy Brief No. 4---4, January.
- Garbade, Kenneth, 2007, ‘‘The Emergence of Regular and Predictable as a Treasury Debt Management Strategy’’ New York Fed, Economic Policy Review, March.
- Gourinchas, Pierre-Olivier and Olivier Jeanne, 2012, ‘‘Global Safe Assets,’’ BIS Working Paper No. 399 (December).
- Singh, Manmohan, 2011, ‘‘Velocity of Pledged Collateral-----Policy and Analysis,’’ IMF Working Paper 11/256.
- Singh, Manmohan, 2013, ‘‘Collateral and Monetary Policy,’’ IMF Working Paper 13/186.
- Singh, Manmohan, 2014, ‘‘Financial Plumbing and Monetary Policy,’’ IMF Working Paper 14/111.
- Singh, Manmohan and Peter Stella, 2012, ‘‘Money and Collateral,’’ IMF Working Paper 12/95
- Stein, Jeremy, 2014, Incorporating Financial Stability Considerations into a Monetary Policy Framework, speech at the International Research Forum on Monetary Policy, Washington, D.C., March 21.
- Stella, Peter, 2015, “Exiting Well,” Stellar Consulting LLC, March.

### Annex I — Some Key Rates Between Zero and 25 Basis Points
- Left-hand side axis measures four rates regularly discussed in Fed speeches and FOMC minutes:
  - ONRRP, or overnight reverse repo progam, rate (green line), presently capped at 5 bps (basis points).
  - IOER, or interest on excess reserves, raet (bold black line) at 25 bps, available to banks only.
  - GCF or general collateral finance, repo index or repo rate (dotted blue line) that approximates the collateral rate in the marketwhen the financial plumbing is normal.
  - FF or federal funds, effective rate (red line), or policy rate target of the Fed.
- Right hand side axis measures volume in the RRP market:
  - The volume (in billions of U.S. dollars) reflects the highest bids accepted by the Fed via Dutch auction.
  - Aside form quarterly-end demand, the RRP cap of $300 billion has been adequate.

### Figure 8 — Relevant Rates and Volumes Between Zero and 25 Basis Points
- Data sources listed: DTCC, Fed, Bloomberg.
- Chart elements and legend entries as presented in the source:
  - ONRRP volume (RHS)
  - DTCC GCF Repo Index
  - Fed Funds Effective Rate
  - US ONRRP Rate
  - IOER
  - Billions (volume axis)
  - Percent (rate axis)

*Source: _wp15202 - REFERENCES (PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15202.pdf_