Simon M Potter: Money markets at a crossroads - policy implementation at a time of structural change Remarks by Mr Simon M Potter, Executive Vice President of the Markets Group of the Federal Reserve Bank of New York, at the Anderson School of Management, Los Angeles, California, 5 April 2017. * * * Accompanying slides Thank you very much. I’m very pleased to be back at UCLA, where I enjoyed eight years in the 1990s as an assistant professor of economics. I’d like to thank my hosts for their gracious invitation to have, once again, the experience of speaking to a classroom of future leaders in finance, business, economics, and—just perhaps—central banking as well.1 Due to the large size of the Federal Reserve’s balance sheet, we are employing a new and innovative framework to control money market rates. Since late 2015, we have seen several significant developments in money markets that have tested this new framework. These include a profound reshaping of the money market fund industry as a result of new Securities and Exchange Commission (SEC) rules, significant shifts in cash management practices at the Treasury and large foreign reserve managers, and continued pressure on bank balance sheets due to the ongoing implementation of Basel III capital requirements. Also since that time, the Federal Open Market Committee (FOMC) has directed three 25 basis point increases in its target range for the federal funds rate.
As a result, they expect that, as the FOMC increases the federal funds rate over time, other interest rates might not rise one-forone with it. As one consequence of this, they express a concern that the Federal Reserve might see greater use of its ON RRP operations over time as monetary policy is tightened, because the rates offered on these operations—presumably rising one-for-one with changes in the target federal funds rate range—will become increasingly attractive relative to other market rates, which they expect to rise more slowly. To date, at least, this does not appear to be happening. I think this paper makes an important point about transmission: monetary control does not stop at the effective federal funds rate, and our framework must ensure that the stance of monetary policy is passed through into other money market rates. However, I am less persuaded that the data supports Darrell and Arvind’s concern about the present efficacy of the framework. First, I think the recent pickup in dispersion we see in money markets might not tell us much about what will happen going forward. A lot of what has happened in money markets in recent years may relate to one-off factors associated with money market fund reform and with liftoff from the zero lower bound.