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

["ÁÎ×Ó¹â HenryC.K.Liu ¹ù¤l¥ú" <hliu@xxxxxxxxxxxxxx>]

Warren Mosler wrote:

> 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.

Or the banks go to the repo market.  The repo market reduces the relevance of
the discount rate.

> It ususally works out that a given net short position results in a given
> spread of fed funds over the discount rate.

Warren, vis-a-vis our discussion a while back, you have just laid out the
logic of an arbitrage paly between the ff rate and 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.

BTW, the current discount rate is 5.25%.  The ususal spread between it and the
ff rate is 0.5%.  The Fed sometimes widens or narrows the spread to accelerate
of decelerate the momentum of its moves, as you describe below.

>  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.

Not only no stigma, but it is viewed as good corporate citizenship in Japan.

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

Henry C.K. Liu