In a statement, the New York Fed emphasized that the tests are being conducted "to ensure operational readiness at the Federal Reserve, the tri-party repo clearing banks and the primary dealers" should the Federal Open Market Committee decide that reverse repos should be used. This round of testing "does not represent any change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future," according to the statement. "Specifically, the aggregate amount of outstanding transactions will be very small relative to the level of excess reserves, and the transactions will be conducted at current market rates."
The New York Fed had signaled the possibility of conducting the tests in a statement it issued in mid-October. "Numerous Federal Reserve communications have indicated that reverse repos are a tool that could be used to support a reduction in monetary accommodation at the appropriate time," according to the Oct. 19 statement.
As the minutes from the Federal Open Market Committee's Nov. 3-4 meeting make clear, there's a difference of opinion on how best to start paring down the Fed's $2-trillion balance sheet. Some meeting participants felt that outright asset sales "could be a useful tool" to reduce the size of the balance sheet and lower the level of reserve balances, either prior to or concurrently with increasing the policy rate. In their view, "such sales would help reinforce the effectiveness of paying interest on excess reserves as an instrument for firming policy at the appropriate time and would help quicken the restoration of a balance sheet composition in which Treasury securities were the predominant asset."
Meanwhile, other participants at the Nov. 3-4 meeting expressed reservations about asset sales, on grounds that the sales "might elicit sharp increases in longer-term interest rates that could undermine attainment of the Committee's goals." Instead, they favored other reserve management tools such as reverse repos and term deposits, which they believe "would likely be sufficient to implement an appropriate exit strategy."
The New York Fed uses repos to make collateralized loans to primary dealers. In a reverse repo, the Fed borrows money from primary dealers, usually overnight but sometimes under terms that extend the borrowing to 65 business days.
The idea, according to the New York Fed, is to offset temporary swings in bank reserves. "A repo temporarily adds reserve balances to the banking system, while reverse repos temporarily drain balances from the system," the bank says.
Results from the forthcoming round of tests will be posted on the New York Fed's public website along with other temporary open market operation results, at www.newyorkfed.org. They will also appear in the Federal Reserve System's consolidated balance sheet statements, issued each Thursday.
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Paul Bubny
Paul Bubny is managing editor of Real Estate Forum and GlobeSt.com. He has been reporting on business since 1988 and on commercial real estate since 2007. He is based at ALM Real Estate Media Group's offices in New York City.
