As promised on Friday, here are a few thoughts on the section of the last FOMC minutes around “Liftoff tools and options”.
The first thing that struck me was the following: “In their discussion of these issues, participants generally agreed that it was very important for the commencement of policy firming to proceed successfully. Consequently, most [my emphasis] were prepared to take the steps necessary to ensure that the federal funds rate traded within the target range established by the Federal Open Market Committee (FOMC).”
Following some of the nonsense that has appeared in the minutes over the past year or so on options for liftoff (eg some thinking that O/N RRP will not be needed), this commitment seems to bind them to doing whatever it takes to keep the FF rate within their target range. This might seem so obvious as to not need stating, but the fact that they didn’t all agree is still pretty weird/worrying. Presumably it is a small fringe minority. And it is worth remembering that since its introduction back in October 2008, IOER has not really performed anywhere near as effectively as hoped. It has essentially been a leaky floor for Fed Funds. (Two very good speeches from Simon Potter of the NY Fed explain this in more detail: Potter (2013) and Potter (2014))
In terms of the details, it seems that most are happy to have a sufficiently large aggregate cap on the O/N RRP facility at time of lift-off such that it is not binding. In other words, it is essentially an unlimited facility. Why then they don’t just have it as unlimited I am not sure, but they still seem concerned about longer-run implication and the need to eventually exit from RRP. The risk, of course, is that they set a cap that is indeed binding, in which case they will need to move quickly to ensure that FF doesn’t trade below the corridor.
While unlikely to be a cornerstone of the normalisation process, the term RRPs also seem to have sufficient support to warrant some use in managing liquidity. It is worth remembering that these ‘term’ facilities are currently only one week, and so are pretty close substitutes for the O/N drain. In many other jurisdictions, liquidity drains are usually at least one week, so this is hardly radical stuff.
Finally, they seem set on having the IOER rate at the top of the band and the O/N RRP rate at the bottom. I have to admit that when this was first suggested last year I was pretty surprised. I really thought that they would equalise the rates and in so doing, would have a single Fed Funds target rate, rather than a corridor. After all, if the combination of the IOER and RRP is successful, then the floor would no longer be leaky and they would have achieved something similar to what the BoE have done. But they seem sufficiently uncertain about their likelihood of success, that a 25bp band seems safer. Quite where it will sit inside that band remains to be seen.