Re: The Repo Market Time Bomb

[wfhummel@xxxxxxxxxxxx (William F. Hummel)]

Barkley:

>William,
>      But in the process of, as you put it, "using the
>repo market as a medium," the Fed influences the
>repo rate.  Thus the changes are there first and only
>afterwards on the fed funds rate.  It is true that the Fed's
>actions affect system reserves and thus influence the
>setting of the ffr by the banks.

The Fed's OMO cannot _directly_ influence the repo rate to any
significant degree because that market is too large.  It can
however easily influence the availability of reserves with
relatively little in funds, and that has a direct effect on the
Fed funds rate, i.e. the overnight rate on sale and purchase of
reserves directly between banks.  Thus your statement above that
the repo rate changes first and only afterwards the Fed funds
rate is simply untenable.

>      I think that we are getting close to a mere semantic
>difference here, once we get the timing bit clear. I fully
>agree that the ffr is the target, primary or whatever, of the
>Fed.  If you wish to call the changes in the repo rate as
>merely incidental (if prior) on the way to the desired changes
>in the ffr, that is OK by me.
>Barkley Rosser

The distinction I am making is more than semantic.  I am saying
the repo rate tracks the Fed funds rate in a very real sense.
Since overnight repos are closely linked to the Fed funds rate,
it may seem like hairsplitting to talk of cause and effect.  But
as long as we are doing so (Henry Liu's initiative and your
followup), then we should make the proper distinction.

William F Hummel

>-----Original Message-----
>From: William F. Hummel <wfhummel@xxxxxxxxxxxx>
>To: POST-KEYNESIAN THOUGHT <pkt@xxxxxxxxxxxxxxxx>
>Date: Monday, April 12, 1999 2:58 PM
>Subject: Re: The Repo Market Time Bomb
>
>
>>Barkley,
>>
>>I was reacting to your words:
>>
>>"Thus it is accurate to say that what the Fed directly influences
>>is the repo rate and through it the fed funds rate, its
>>intermediate target."
>>
>>I think that clearly reads that the Fed influences the repo rate
>>in order to control the Fed funds rate.  Of course that is
>>precisely backwards.  The banks themselves set the Fed funds rate
>>based on the supply-demand for reserves.  The repo market for
>>banks can only redistribute those reserves.  The Fed however
>>directly influences the availability of system reserves through
>>its OMO, using repos as a medium.  If the Fed decided to increase
>>the FFR by 100 basis points, it could quickly do so by draining
>>some banking system reserves.  Other short term interest rates
>>would follow with varying time lags depending on the term.
>>
>>Short term repos rates will be affected more quickly than say the
>>13 week T-bill rates.  So too will the short term eurodollar
>>market quickly respond to a change in the Fed funds rate.  While
>>it's true these markets are linked, I think it is misleading to
>>imply that the Fed funds rate is tracking rather than leading
>>repo rates.
>>
>>William F. Hummel
>>
>>>William,
>>>     You are confusing things.  I fully agree that the
>>>"target" ("primary" if you prefer) is the fed funds
>>>rate.  That's what they decide on at the FOMC
>>>meetings.  As my friend at the Fed (who has been
>>>there a very long time and is pretty high up) put it,
>>>the fact that the Fed operates through the repo
>>>market is a "technicality."  But the fact that they do
>>>so means that what is most immediately and directly
>>>affected by their actions is the repo rate.  The two rates
>>>are linked and hence affecting means affecting the other.
>>>     Henry C.K. Liu's characterization of the situation
>>>remains accurate.
>>>Barkley Rosser
>>>-----Original Message-----
>>>From: William F. Hummel <wfhummel@xxxxxxxxxxxx>
>>>To: POST-KEYNESIAN THOUGHT <pkt@xxxxxxxxxxxxxxxx>
>>>Date: Saturday, April 10, 1999 12:59 PM
>>>Subject: Re: The Repo Market Time Bomb
>>>
>>>
>>>>Barkley Rosser wrote:
>>>>
>>>>>      A clarification of this is that the FOMC decides
>>>>>on an fed funds rate that it wishes to hold.  But the
>>>>>actual open market operations of Fed are carried
>>>>>out in the repo market and have been for many years,
>>>>>as described by Henry C.K. Liu.  Thus it is accurate
>>>>>to say that what the Fed directly influences is the repo
>>>>>rate and through it the fed funds rate, its intermediate
>>>>>target.   The fact that Fed open market ops actually
>>>>>are mostly in the repo market is not widely known and
>>>>>not reported in most money and banking or macro
>>>>>textbooks.
>>>>>     BTW, I first learned of this many years ago from
>>>>>a friend of mine at the Board of Governors.
>>>>>Barkley Rosser
>>>>
>>>>This is simply wrong.  It is well-known that the Fed conducts its
>>>>open market operations through repos to directly control the Fed
>>>>funds rate, not the repo rate.  The private sector repo market is
>>>>far too large for the Fed to have any _direct_ influence on.
>>>>That market merely redistributes existing reserves but does not
>>>>affect the total.  Only the Fed's OMO can affect the total and
>>>>thus the balance of supply and demand for Fed funds.  The Fed
>>>>funds rate is clearly the primary target, notwithstanding any
>>>>misconception by a friend at the Board of Governors.
>>>>
>>>>William F. Hummel
>>>>
>>>>
>>>>
>>
>>