4  BIS central bankers’ speeches  Federal Reserve’s role in financial intermediation – particularly if it were permanently in place – by expanding the Federal Reserve’s presence in short-term funding markets or potentially altering the structure and functioning of money markets in unanticipated ways. 10 These risks are likely small given the sizable level of excess reserves currently in the system, which establishes the Federal Reserve’s large footprint in money markets. However, the risks associated with offering a perfectly elastic supply of ON RRPs at a fixed rate could increase as the level of excess reserves declines over the course of normalization and an ON RRP facility becomes less important to support interest rate control. These risks inform the Committee’s desire to phase the facility out when it is no longer needed to control the federal funds rate. Indeed, money market rates should become more closely aligned with the IOER rate as the quantity of reserve balances in the system approaches greater levels of scarcity, likely reducing the need for supplementary support from an ON RRP facility. And since ON RRPs just swap one Federal Reserve liability for another – reserves for reverse repos – demand for RRPs should recede as the asset side of the Fed’s balance sheet shrinks.
The difference between the sale price and the repurchase price, together with the length of time between the two legs of the transaction, implies a rate of interest (the reverse repo rate) paid by the Federal Reserve to its counterparty. The transaction leaves the size of the SOMA’s securities portfolio unchanged, but shifts some of the liabilities on the Fed’s balance sheet from bank reserves to reverse repos while the trade is outstanding  7  Unlike IOER, however, a full-allotment ON RRP facility would theoretically offer a perfectly elastic supply of a safe asset at a fixed rate. In practice, the amount of ON RRPs that the Federal Reserve could supply would likely be limited by the lesser of the level of excess reserves or the amount of securities available from the SOMA portfolio for such transactions. BIS central bankers’ speeches  3  point target, is viewed as appropriate for providing some flexibility in interest rate control when the quantity of reserves remains elevated. As for the Fed’s tools for policy implementation, setting the IOER and ON RRP rates at the upper and lower bounds of the target range is a straightforward arrangement at the start of policy firming.