The Longer-Term Lessons of the Repo Turmoill

https://www.bloomberg.com/opinion/articles/2019-10-23/the-longer-term-lessons-of-the-repo-market-turmoil

The new regime has three important advantages.

First, it’s much easier to operate. The Fed doesn’t have to adjust the supply of reserves every day to keep the federal funds rate close to its target. It needs only to ensure that banks have plenty of cash. The interest rate on reserves will do the rest.


Second, it allows the Fed to provide as much cash as needed to combat financial stress. Under the old regime, the Fed couldn’t credibly commit to such an open-ended backstop, because the added liquidity could push the federal funds rate below its target – that is, the central bank could lose control of monetary policy. Now, with the interest rate on reserves acting as a floor, the Fed no longer has that constraint.


Third, it makes the banking system more efficient and safer. As long as the Fed provides ample reserves, banks will always have plenty of cash to facilitate payments. They also won’t need to do much lending and borrowing of reserves in the federal funds market — an activity that, under the old regime, created a lot of counterparty risk without much benefit.


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