It is unclear to me why the Federal Reserve would want to apply more stimulus at a time when market conditions were improving. This suggests that some variability in the trajectory of the Fed’s balance should be expected and might even be desirable. And, in fact, this is what we have seen in practice. Third, I am not worried at all that the Federal Reserve’s balance sheet expansion will generate an inflation problem. It should be emphasized that the Federal Reserve has the ability to manage down the size of its balance sheet over time once financial conditions and the economy improve. Many of the liquidity facilities will shrink automatically as financial conditions normalize. With the exception of TAF loans, all of the other Fed liquidity facilities charge rates that are higher than what one would expect during more normal financial circumstances. And, if we want the TAF loans to shrink, we can either shrink the amounts on offer or raise the interest rate we charge, or both. The other assets such as Treasury securities and agency MBS can be sold or the impact on reserves be offset by repurchase operations that drain reserves from the banking system. More importantly, the Federal Reserve now has the tools to allow the conduct of monetary policy to be separated from the size of the balance sheet and the amount of excess reserves in the banking system. In September 2008, the Federal Reserve gained the authority to pay interest on excess reserves.
As the financial condition of some of the major securities dealers worsened, the clearing banks became more  2  BIS Review 48/2009  reluctant to return the cash that the triparty repo investors had invested the prior evening. The clearing banks were worried that if a dealer were to fail, they could be stuck with a large obligation. The nervousness of the clearing banks, in turn, spilled back to the investors. If there is some chance that I might not get my cash back and instead be stuck with the collateral, do I really want to make the loan in the first place? The Primary Dealer Credit Facility essentially broke this dynamic by putting the Federal Reserve in the position of lender of last resort in the triparty repo system. With the Federal Reserve willing to lend against collateral, the clearing banks no longer have significant intraday risk exposure. The triparty repo investors have been reassured that they would be paid back. As a consequence, they were willing to keep investing. The TAF and the dollar facilities offered by foreign central banks provided the same antidote to rollover risk in the interbank funding markets. Banks that were reluctant to lend to one another because of rollover risk became willing to reengage because they knew that the Federal Reserve and foreign central banks would lend against high-quality collateral. By eliminating rollover risk, the CPFF also helped to restore market function in the commercial paper market.