Policymakers now had the capacity to expand the size of the Fed’s liquidity facilities and other programs without the threat of compromising the control of monetary policy. This new tool immediately proved enormously helpful. The Fed was able to respond to the deterioration of conditions in the fall of 2008 by sharply increasing the size of its Term Auction Facility program and removing the limits on the size of many of the foreign exchange swap programs. These programs, along with the increased use of the Fed’s standing liquidity facilities and the start-up of the Commercial Paper Funding Facility in late October, led to a sharp growth in the Federal Reserve’s balance sheet beginning in late September. The third phase is marked by the launch of the Fed’s purchase programs, starting with the agency debt program that began in December 2008 and extends through to the present. During this phase, the Fed’s overall balance sheet has actually declined slightly. The demand for the Fed’s special liquidity programs has diminished more quickly than the purchase programs have been ramped up. Although this shrinkage was not anticipated or targeted, it is a welcome indication that there has been improvement in the functioning of the short-term funding markets. 1 As market function has improved and credit spreads have narrowed, many of the Fed’s liquidity facilities have become less attractive and there has been a corresponding decline in usage.
Second, unlike interbank funding, central bank refinancing over a 30-day horizon would not count as an outflow in the denominator of LCR, as it always benefits from a 100% rollover rate. As a result of these two features taken together, this could increase demand for central bank refinancing. Banks could exploit regulatory arbitrage opportunities by posting non-HQLA as collateral, which would lead to an increase in the LCR.12 While this also  9  An exception is Hilberg and Hollmayr (2011). They extend a New-Keynesian model introducing an interbank market and allowing the central banks to alleviate the liquidity shortage on the interbank market varying haircuts on eligible assets; see B. Hilberg and J. Hollmayr (2011), “Asset prices, collateral and unconventional monetary policy in a DSGE model”, European Central Bank working paper series, No 1373. For a discussion on collateral used in private transactions see G. Gorton and A. Metrick (op. cit.) and J. Geanakoplos (2010), “The Leverage Cycle” in D. Acemoglu, K. Rogoff and M. Woodford, eds., NBER Macroeconomic Annual 2009, vol. 24, pp. 1–65, University of Chicago Press. 10  Bindseil (2013) discusses how the collateral framework can interact with liquidity regulation; see U. Bindseil (2013) “Central bank collateral, asset fire sales, regulation, and liquidity”, mimeo, European Central Bank. For a description of the Eurosystem collateral framework, see the ECB website, http://www.ecb.europa.eu/ paym/coll/html/index.en.html.