But, if you look closely, you’d see that excess reserves actually  1  An extended effort to evaluate potential long-run monetary policy implementation frameworks was announced in the July 2015 Federal Open Market Committee (FOMC) meeting minutes. This effort was previously discussed at the dinner address for the Bank of England-Federal Reserve Bank of New York Conference on Money Markets and Monetary Policy Implementation. 2  Congress had agreed to give the Federal Reserve the authority to pay interest on reserves in 2006, but this authority was to take effect on 2011. The effective date of the authority was moved forward to October 1, 2008, with the passage of the Emergency Economic Stabilization Act of 2008. 3  The FOMC published its Policy Normalization Principles and Plans on September 16, 2014. BIS central bankers’ speeches  1  started expanding earlier and control of the federal funds rate deteriorated. 4 So what happened? In reviewing the events of the second half of 2007 and most of 2008, it is clear that the Federal Reserve faced a tension between the need to provide liquidity to ease money market strains and the need to keep control of the interest rate target within its earlier framework. Demand for dollar liquidity increased in many money markets and some of that demand came from banks headquartered outside of the United States. A by-product of the Federal Reserve’s efforts to provide liquidity to the financial system is that the supply of reserves, which can only be held by banks, increased.
I am not claiming that the current framework is perfect, or that it is necessarily better than the old framework augmented with the new tools used to directly absorb excess reserves, but it is useful to have flexibility in how to implement monetary policy. We have now seen in practice that changes in administered rates can effectively move market rates – both because effective competition helps bring administered and market rates closer together and because the mere existence of administered-rate facilities, like the RRPs I mentioned earlier, can affect competition between private borrowers and investors even when these facilities see little usage. As we learn more about the practical aspects of using these mechanisms to influence money market rates in the United States, a much wider range of potential operating frameworks becomes viable. It will now be important to make sure that all the costs and benefits of different approaches are considered carefully to get the most effective framework for monetary policy implementation. In particular, there are important trade-offs that may need to be considered in a framework that can flexibly provide liquidity for monetary policy implementation and broader transmission. It is possible, for example, that financial market participants may anticipate that the central bank will make liquidity plentiful during times of stress and that this could reduce their incentives to manage their liquidity conservatively. For banks, new Basel III liquidity regulation, such as the liquidity coverage ratio and the net stable funding ratio, partially mitigates this concern.