Challenges in Repo Markets: Financial Stability, Monetary Policy Frameworks

This workshop will include lectures by and discussion with senior level experts in the field.

More than ten years after the Global Financial Crisis, despite unprecedented actions by monetary and financial stability authorities, serious problems remain in place. Among them is the emerging problems in the repo market that requires the Fed to resume purchases of Treasury securities in an effort to avoid a repeat of the recent turmoil in money markets. This mini-course will debate the problems in the repo market in detail. We will offer up to two sessions on the following topics:

1. Fed’s responses to the turbulence in the repo market;

The turmoil in the repo market in September 2019 seems to be a significant stressor for the Fed. Then, big banks that normally lend cash short term to other financial companies pulled back due to their balance sheet constraints, causing money-market rates to go up. Most notably, the federal-funds rate, a key focus of central-bank policy, moved above its range. The Fed has been adding large amounts of short-term liquidity to financial markets since September 2019, when short-term interest rates surged unexpectedly. The operations in the form of repurchase agreements, or repos, take in bonds from eligible banks in what is effectively a short-term loan of central-bank cash, collateralized by the securities. When the Fed restarted its repo operations after a halt for just over a decade, it said it was a temporary operation and it expected to wind them down by the end of January 2020, as Treasury-bill buying bolstered underlying reserves levels. However, even though Fed repo operations have brought calm to money markets, recent comments from a top Fed official, as well as market expectations, likely point to repos operations being continued into the spring, as the Fed is still looking for a more effective solution to keep short-term rates in line with central bank goals.

2. Repo market turbulence and its implications for the implementation of monetary policy;

New concerns have emerged regarding the Fed’s continuous ability to control the interest rate. Developments in the financial market such as growing U.S. budget deficit, investors’ increased cash hoarding desire, and pressures on the money market rates such as repo rates are urging these fears. The standard sentiment is that Fed’s control over interests rate determines the price of reserves, which in turn eliminates any form of excess supply or excess demand in the market for reserves. In doing so, the Fed maintains its authority to stabilize the money market, where the price of short-term funding is determined. The problem is that in modern finance, most financial participants finance their liquidity requirements mainly through selling their securities holdings, or using them as collateral in the repo market rather than demanding reserves directly. Hence, the readiness of repo market to supply funding liquidity as well as the dealers to provide market liquidity have higher priority than the supply of reserves. In other words, the interest rate, or price of liquidity, is determined by the expansion of dealers balance sheets on both sides rather than by the supply and demand for reserves. Therefore, as Perry Mehrling argues, central bank watchers’ focus should deviate from the Fed’s ability to control the price of reserves, which is the federal funds rate, to its ability to affect market and funding liquidity. This also entails an intellectual migration from a supply and demand framework towards a Flow of Funds accounting perspective.

How to Attend

Anyone with an interest in the topic is encouraged to apply. Workshop participants are also invited to the INET Conference that will follow on 14-15 April, ahead of the IMF and World Bank Meetings on 16-18 April. Interested participants residing outside the DC area may request to be considered for partial travel support and/or accommodation. In your application, please attach your CV and motivation, and elaborate on how your work and your interests align with the goals of the workshop, and the partner organization.