During the financial crisis, this spread rose and fell with changes in investors’ perception of bank credit risk. In contrast, its recent moves are related to money market fund reform: term rates rose considerably as prime money market funds both shrunk in size and reduced their maturities to remain highly liquid, and have recently come back a bit as the market has stabilized and markets have adapted to the new industry structure. Shown in (Figure 15) are customer-to-dealer versus dealer-to-dealer Treasury repo rates. The customer-to-dealer market consists primarily of cash investors like money market funds lending to dealers, while the dealer-to-dealer market reflects dealers lending amongst themselves.31 The 8 / 13  BIS central bankers' speeches  spread between these two rates is thus a proxy for the cost dealers with ready access to cashinvestor financing charge to act as intermediaries between these two markets. Since all the lending is secured by Treasuries, this intermediation entails very modest risk. U.S. versus currency-hedged 3-month interest rates, as reflected by foreign exchange basis swaps, are shown in (Figure 16). U.S. and foreign money markets are linked together by a dealer-intermediated foreign exchange derivatives market, which allows firms to essentially convert money market loans and borrowings from one currency into another. A dealer that intermediates this spread can be thought of conceptually as making a secured loan, in which it lends out dollars and takes in foreign currency cash as collateral.
As always, these views are mine alone and do not necessarily reflect those of the New York Fed or the Federal Reserve System. My comments today are, in part, a condensed version of “Domestic Open Market Operations During 2016,” a report prepared by the Markets Group of the New York Fed for the FOMC. This annual report provides extensive and illuminating detail on the Federal Reserve’s operations and balance sheet. It is published as part of our mission to make monetary policy transparent and accessible to the public. The report will be published tomorrow on the New York Fed’s website and I encourage you to read it. Our new policy framework: a review 1 / 13  BIS central bankers' speeches  Let me start out by reviewing two basic questions: what is our framework for implementing monetary policy, and why has it changed so much? Before the financial crisis, the Federal Reserve followed a well-worn playbook for monetary policy implementation that was based on keeping reserve balances scarce.2 Even though the Federal Reserve paid zero percent interest on reserves, banks still needed to hold small amounts of them, mainly to satisfy their reserve requirement but also for operational liquidity. The demand for reserves by banks was downward sloping (and steep).