Re: Fed open market operations, reply-comment on Mossler

[Warren Mosler <mosler@xxxxxxxx>]

Christopher Niggle wrote:

> Warren, other interested parties:
>
> Although most NY Fed operations are "defensive" and compensate or offset
> Treasury operations, not all are: when the Fed is changing the ff rate
> (say, tightening) it is actively changing the rate.  And it then must
> deliberately oppose private sector activities in order to maintain that
> higher rate.

Chris,

Currently, in the US, the Fed limits it open market 'adds' such that
the banks must borrow a few $ at the discount window to meet their
reserve requirements.  Because there is a 'stigma' for banks that
borrow from the window, banks would rather buy funds from each
other than from the Fed.  By keeping the banking system net short
(by the bank's calculations) they begin bidding for fed funds from
each other at higher and higher spreads over the discount rate until
some banks decide to borrow at the window at the lower rate rather
than pay the higher rate from another bank.  It ususally works out
that a given net short position results in a given spread of fed funds
over the discount rate.  So, for example, a discount rate of 5.5% and
$200 million of borrowings at the window might correspond to a 5.75%
fed funds rate.  If the DC Fed decides to raise the funds rate to, say,
6% it can simply raise the discount rate to 5.75% which, with the
same net borrowed position of $200 million, result in a 6% fed funds
rate.  Often, however, for political reasons, the DC Fed may leave the
discount rate at 5.5%.  In that case, the NY Fed, to meet the new target
of 6%, will increase the banks need to borrow from the window (by
supplying less non borrowed reserves through its open market operations)
until the funds rate stabilizes around 6%.  This will then be seen to
correspond to a higher net borrowed position, perhaps $350 million.
The process is the same.  Banks borrow from each other but now that
$350 must be borrowed from the window it takes the wider spreads
off of the discount rates to induce more banks to decide to borrow
at the window.  (Note that the mix between borrowed and non borrowed
changes, but the total remains the same.)

By the way, IMHO, this is a very silly way to run a clearing system.
It is a holdover from the gold standard, at best.
Other countries simply have no stigma attached to borrowing at the
window and change the fed funds rate by changing the discount rate.

This process if outlined in more detail in 'Soft Currency Economics'
also on http://www.warrenmosler.com

> Chris

w