Treasury Direct

A common argument against retail central bank digital currency (CBDC) is that CBDC would undermine financial stability by allowing the general public to swiftly move funds from banks to a government account. But in several countries such swift transfers are possible already today—in the US through Treasury Direct.

(The argument also has conceptual flaws, see the paper On the Equivalence of Public and Private Money with Markus Brunnermeier.)

U.S. Money Markets

For over a year the federal funds rate has increased relative to the rate the Fed pays on excess reserves. In mid September 2019, the federal funds rate increased abruptly, triggering the Fed to inject fresh funds. In parallel, the repo market rates spiked dramatically.

On the Cato Institute’s blog, George Selgin argues that structurally elevated demand collided with reduced supply. He mentions explicit and implicit regulation; Treasury General Account (TGA) balances; the NY Fed’s foreign repo pool (Japanese banks); and the administration’s $1 trillion deficit which required primary dealers to underwrite newly-issued government debt.

The bottom line is that regulators have managed to raise the biggest banks liquidity needs enough to compel them to sit on most of the banking system’s seemingly huge stock of excess reserves, and to do so even as repo markets present them with an opportunities to earn five times what those reserves are yielding just by lending them out overnight.

… So there you have it: a host of developments adding to banks’ demand for excess reserves, while others gradually chipped away at the stock of such reserves. Add a spike in primary dealers’ demand for short-term funding, a coinciding round of tax payments that transferred as many reserves to the TGA, and binding intraday liquidity requirements at the banks holding a large share of total system excess reserves, and you have the makings of last month’s perfect repo-market storm.

David Andolfatto and Jane Ihrig concur. On the Federal Reserve Bank of St. Louis’ On the Economy Blog, they already argued in March 2019 that banks feel compelled to hoard reserves rather than lending against treasuries:

Why should banks prefer reserves to higher-yielding Treasuries? One explanation is that Treasuries are not really cash equivalent if funds are needed immediately. In particular, for resolution planning purposes, banks may worry about the market value they would receive in the sale of or agreement to repurchase their securities in an individual stress scenario.

Consistent with this possibility, Federal Reserve Vice Chair for Supervision Randal Quarles noted, “Occasionally we hear that banks feel they are under supervisory pressure to satisfy their [high-quality liquid assets] with reserves rather than Treasury securities.”

To quantify this liquidity consideration, a recent post on the Federal Reserve Bank of New York’s Liberty Street Economics blog suggests that the eight domestic Large Institution Supervision Coordinating Committee’s banks collectively may want to hold $784 billion in precautionary reserves to cover their immediate liquidity needs in times of stress.

Andolfatto and Ihrig argue that the precautionary reserves hoarding by banks could substantially be reduced if the Fed offered a standing repo facility:

The Fed could easily incentivize banks to reduce their demand for reserves by operating a standing overnight repurchase (repo) facility that would permit banks to convert Treasuries to reserves on demand at an administered rate. This administered rate could be set a bit above market rates—perhaps several basis points above the top of the federal funds target range—so that the facility is not used every day …

With this facility in place, banks should feel comfortable holding Treasuries to help accommodate stress scenarios instead of reserves. The demand for reserves would decline substantially as a result. Ample reserves—and therefore the size of the Fed’s balance sheet—could in fact be much closer to their historical levels.

A standing repo facility could effectively impose a ceiling on repo rates. And as Andolfatto and Ihrig argue it would also have other benefits. In a follow up post, Andolfatto and Ihrig emphasize that,

[w]hile U.S. Treasuries are given equal weight with reserves in the calculation of high-quality liquid assets (HQLA) for the LCR, they are evidently not considered equivalent for resolution purposes.

Internal liquidity stress tests apparently assume a significant discount on Treasury securities liquidated in large volumes during times of stress, so that Treasuries are not treated as cash-equivalent. We have heard that banks occasionally feel under supervisory pressure to satisfy their HQLA requirements with reserves rather than Treasuries.

On the NewMonetarism blog, Stephen Williamson offers a longer-term perspective. He appears more skeptical as far as bank liquidity requirements as a possible explanation for the recent interest rate spikes are concerned. In Williamson’s view a floor system that requires even more reserves in the banking system than currently present is ineffective and should be replaced. He writes (my emphasis):

Before the financial crisis, the Fed intervened on the supply side of the overnight credit market by varying the quantity of its lending in the repo market so as to peg the fed funds rate. … a corridor system, as the central bank’s interest rate target was bounded above by the discount rate, and below by the interest rate on reserves, which was zero at the time. But, the Fed could have chosen to run a corridor by intervening on the other side of the market – by varying the quantity of reverse repos, for example. Post-financial crisis, the Fed’s floor system is effectively a mechanism for intervening on the demand side … With a large quantity reserves outstanding, those financial institutions holding reserves accounts have the option of lending to the Fed at the interest rate on reserves, or lending in the market – fed funds or repo market. Financial market arbitrage, in a frictionless world, would then look after the rest. By pegging the interest rate on excess reserves (IOER), the Fed should in principle peg overnight rates.

The problem is that overnight markets – particularly in the United States – are gummed up with various frictions. … Friction in U.S. overnight credit markets … is nothing new. Indeed, the big worry at the Fed, when “liftoff” from the 0-0.25% fed funds rate trading range occurred in December 2015, was that arbitrage would not work to peg overnight rates in a higher range. That’s why the Fed introduced the ON-RRP, or overnight reverse-repo, facility, with the ON-RRP rate set at the bottom of the fed funds rate target range, and IOER at the top of the range. The idea was that the ON-RRP rate would bound the fed funds rate from below.

… if total reserves outstanding are constant and general account balances go up, then reserve balances held in the private sector must go down by the same amount. The Fed permits these large and fluctuating Treasury balances, apparently because they think this won’t matter in a floor system, as it shouldn’t. … Another drain on private sector reserve balances is the foreign repo pool. … if the problem is low reserve balances in the private sector, those balances could be increased by about $300 billion if the Fed eliminated the foreign repo pool.

… The key problem is that the Fed is trying to manage overnight markets by working from the banking sector, through the stock of reserves. Apparently, that just won’t work in the American context, because market frictions are too severe. In particular, these frictions segment banks from the rest of the financial sector in various ways. The appropriate type of daily intervention for the Fed is in the repo market, which is more broadly-based. If $1.5 trillion in reserve balances isn’t enough to make a floor system work, without intervention through either a reverse-repo or repo facility, then that’s a bad floor system. … Make the secured overnight financing rate the policy rate, and run a corridor system. That’s what normal central banks do.

Some background information:

  • NY Fed commentary on monetary policy implementation.
  • Description (2009) of the primary dealer system, by Barry Ritzholtz.
  • NY Fed staff report (2015) on US repo and securities lending markets, by Viktoria Baklanova, Adam Copeland and Rebecca McCaughrin.

In the FT, Cale Tilford, Joe Rennison, Laura Noonan, Colby Smith, and Brendan Greeley “break down what went wrong, what happens next, and whether markets can avoid another cash crunch” (with many figures).

This post was updated on November 21, 11:09 pm; and on November 26 (FT article).

More Endorsements for “Macroeconomic Analysis”

“This is an excellent textbook for macroeconomics at the master’s or beginning PhD level. The topics and the material used to cover them are well chosen; the treatment gives a solid and unified background for positive and normative analysis. It strikes a good balance between being conceptually clear and logically consistent, and at the same time quite accessible.”
Fernando Alvarez, Saieh Family Professor of Economics, University of Chicago

Forthcoming, MIT Press.
MIT Press book page. My book page.

India’s Unified Payments Interface

In the FT, Benjamin Parkin reports about the transformation of India’s payments landscape.

Behind the boom is an innovation launched by the Indian government in 2016: the unglamorous sounding Unified Payments Interface, or UPI, which allows immediate mobile payments directly between bank accounts.

Conceived as a public utility, the service is transforming India’s cash-dependent economy into fertile soil for mobile-money apps. … Both the volume and value of transactions had more than doubled in a year.

Harvard’s Admissions Policy

A paper by Peter Arcidiacono, Josh Kinsler, and Tyler Ransom offers some glimpses.

The lawsuit Students For Fair Admissions v. Harvard University provided an unprecedented look at how an elite school makes admissions decisions. Using publicly released reports, we examine the preferences Harvard gives for recruited athletes, legacies, those on the dean’s interest list, and children of faculty and staff (ALDCs). Among white admits, over 43% are ALDC. Among admits who are African American, Asian American, and Hispanic, the share is less than 16% each. Our model of admissions shows that roughly three quarters of white ALDC admits would have been rejected if they had been treated as white non-ALDCs. Removing preferences for athletes and legacies would significantly alter the racial distribution of admitted students, with the share of white admits falling and all other groups rising or remaining unchanged.

Where the Phillips Curve is Alive, Contd

In an NBER working paper, Laurence Ball and Sandeep Mazumder question the puzzles of first, missing disinflation and subsequently, missing inflation in the Euro area. From the abstract:

… we measure core inflation with the weighted median of industry inflation rates, which is less volatile than the common measure of inflation excluding food and energy prices. We find that fluctuations in core inflation since the creation of the euro are well explained by three factors: expected inflation (as measured by surveys of forecasters); the output gap (as measured by the OECD); and the pass-through of movements in headline inflation. Our specification resolves the puzzle of a “missing disinflation” after the Great Recession, and it diminishes the puzzle of a “missing inflation” during the recent economic recovery.

See also the paper by James Stock and Mark Watson.

More Endorsements for “Macroeconomic Analysis”

“Finally, a book that fills the longstanding, and growing, gap between existing undergraduate and graduate macroeconomics textbooks. The winning approach of the author is to rigorously develop the core insights in each topic studied, avoiding superfluous diversions. The emphasis on government policy and political economy is especially useful in interpreting current global macroeconomic events.”
Gianluca Violante, Professor of Economics, Princeton University
(To be continued.)

Forthcoming, MIT Press.
MIT Press book page. My book page.

More Endorsements for “Macroeconomic Analysis”

“Niepelt’s textbook provides a concise, but rigorous introduction to the key concepts, tools, and models that constitute modern macroeconomic theory. His pedagogical approach, introducing the key building blocks of the theory one at a time, and focusing on what is essential at each stage, should make the learning experience a pleasant one. I expect it to become a staple reference in first-year graduate courses.”
Jordi Galí, CREI, Universitat Pompeu Fabra and Barcelona GSE
(To be continued.)

Forthcoming, MIT Press.
MIT Press book page. My book page.

Spyware for Sale

NSO Group “creates technology that helps government agencies prevent and investigate terrorism and crime to save thousands of lives around the globe,” according to the technology group’s website.

But according to the FT (article, article, article), NSO has (also) helped governments around the world to target journalists and dissidents.

The University of Toronto’s Citizen Lab knows more—and offers advice on how to take precautions.

More Endorsements for “Macroeconomic Analysis”

“Macroeconomic Analysis is the rare textbook that is both comprehensive and rigorous, as well as concise and simple. By staying focused on the core model of dynamic macroeconomics, it elegantly navigates through many topics. After studying this book, students will be ready to join the exciting debates in modern macroeconomics.”
Ricardo Reis, A. W. Phillips Professor of Economics, London School of Economics and Political Science
(To be continued.)

Forthcoming, MIT Press. Book page.

More Endorsements for “Macroeconomic Analysis”

“A needed, up-to-date primer on macroeconomic theory. It is comprehensive, covering all the essential topics, from optimal consumption and labor supply to economic growth, business cycles, and asset markets. It is thorough and rigorous, yet accessible, as it requires little prior knowledge of the key concepts and mathematical tools.”
George-Marios Angeletos, Professor of Economics, MIT
(To be continued.)

Forthcoming, MIT Press. Book page.

BIS Stablecoin Report

The BIS has published a report on stablecoins. On Alphaville Izabella Kaminska approves but argues that the report does not contain novel points. One aspect discussed in the report concerns the benefit of stablecoins for cross-border payments; it may be limited unless technology is able to address the key friction:

A major obstacle to the interlinking of domestic payment systems and/or the development of shared global payment platforms is differing legal frameworks across jurisdictions and the associated uncertainty about the enforceability of contractual obligations resulting from participation in interlinked or shared payment platforms operating across borders.

See the VoxEU series on the topic.

More Endorsements for “Macroeconomic Analysis”

“This book provides an excellent introduction into dynamic macroeconomics. Its analysis is deep, self-contained, and still concise. The chapters on labor search frictions, financial frictions, and money are an extra plus and make it a superb choice for a first-year PhD or advanced Masters’ course in macroeconomics.”
Markus Brunnermeier, Edwards S. Sanford Professor of Economics, Princeton University

(To be continued.)

Forthcoming, MIT Press. Book page.

BIS Innovation Hub Centre in Switzerland

From the SNB’s press release regarding the newly established BIS Innovation Hub Centre in Switzerland:

The Swiss Centre will initially conduct research on two projects. The first of these will examine the integration of digital central bank money into a distributed ledger technology infrastructure. This new form of digital central bank money would be aimed at facilitating the settlement of tokenised assets between financial institutions. Tokens are digital assets that can be transferred from one party to another. The project will be carried out as part of a collaboration between the SNB and the SIX Group in the form of a proof of concept.

The second project will address the rise in requirements placed on central banks to be able to effectively track and monitor fast-paced electronic markets. These requirements are arising in particular from the greater automation and fragmentation of the financial markets, but also from the increased use of new technologies.

Thomas Jordan and Agustín Carstens signed the Operational Agreement on the BIS Innovation Hub Centre in Switzerland yesterday.

Costs and Benefits of Unconventional Monetary Policy

The BIS has issued two reports that assess the implications of unconventional monetary policies.

The report prepared by the Committee on the Global Financial System discusses

… a number of unconventional monetary policy tools (UMPTs). After a decade of experience with UMPTs the report takes stock of central banks’ experience and draws some lessons for the future.

The report focuses on four sets of tools: negative interest rate policies, new central bank lending operations, asset purchase programmes, and forward guidance. It offers a summary of central banks’ shared understanding of the efficacy of these tools across countries, as well as the way that they were sequenced and coordinated.

The report concludes that, on balance, UMPTs helped the central banks that used them address the circumstances presented by the crisis and the ensuing economic downturn. It identifies side effects, such as dis-incentives to private sector deleveraging and spillovers to other countries, but does not consider them sufficiently strong to reverse the benefits of UMPTs.

The report also discusses whether, and under what circumstances, these tools could be useful in the future. Central banks report that the tools have earned a place in the monetary policy toolbox, but they also highlight that their use should be accompanied by measures that mitigate their potential side-effects. They also highlight that under the circumstances when the tools can be helpful, they need to be used in decisively but in a context that includes a wider set of policies as to avoid overburdening the central bank.

The report prepared by a Markets Committee study group argues that

… some balance sheet-expanding policies were specifically aimed at improving market functioning, and that they delivered on this front. The potential for adverse side effects arose most clearly at a later stage, when asset purchase programmes were introduced to provide monetary stimulus at the effective lower bound for interest rates. But side effects rarely tightened financial conditions in markets to a point that would have undermined policy effectiveness.

That said, the report finds that some market malfunctioning did arise. In bond markets, adverse effects were mostly associated with asset scarcity, but any such effects were often temporary, in part due to mitigating policies. In money markets, market functioning issues (for example in interbank reserve trading) arose from the abundance of reserves. Yet, other wholesale money markets remained robust and central banks retained sufficient control over short-term rates, typically by introducing new tools. The report acknowledges that prolonged use of large balance sheet policies may have longer-term adverse effects on the market ecosystem, but these are hard to measure at this point.

Entertainment TV, Politics, and Cognitive Skills

In the July issue of the American Economic Review, Ruben Durante, Paolo Pinotti, and Andrea Tesei argue that entertainment TV has shaped Italian politics and affected the cognitive skills of viewers. From the abstract:

We study the political impact of commercial television in Italy exploiting the staggered introduction of Berlusconi’s private TV network, Mediaset, in the early 1980s. We find that individuals with early access to Mediaset all-entertainment content were more likely to vote for Berlusconi’s party in 1994, when he first ran for office. The effect persists for five elections and is driven by heavy TV viewers, namely the very young and the elderly. Regarding possible mechanisms, we find that individuals exposed to entertainment TV as children were less cognitively sophisticated and civic-minded as adults, and ultimately more vulnerable to Berlusconi’s populist rhetoric.

“Libra Paves the Way for Central Bank Digital Currency,” finews and WNM, 2019

My VoxEU column now also on finews and World News Monitor, September 17, 2019.

Digital currencies involve tradeoffs. Libra resolves them less favorably than other projects, and less favorably than CBDC.

When confronted with the choice between the status quo and a new financial architecture with CBDC, most central banks have responded cautiously. But Libra or its next best replica will take this choice off the table – the status quo ceases to be an option. The new choice for monetary authorities and regulators will be one between central bank managed CBDC on the one hand and – riskier – private digital tokens on the other. Central banks have a strong interest to maintain control over the payment system as well as the financial sector more broadly and to defend the attractiveness of their home currency. Nolens volens, they will therefore introduce ‘Reserves for All’ or promote synthetic CBDCs. In economics, things take longer than one thinks they will, as Rudi Dornbusch quipped, but then they happen faster than one thought they could.

How to Prevent Cash Hoarding when Interest Rates are Strongly Negative

On, Fabio Canetg explains how the Swiss National Bank prevents banks from hoarding cash rather than holding reserves at the central bank (which pay negative interest). He points to the following sentence in the SNB’s December 2014 press release (my emphasis) and he speculates that banks could, in principle, implement similar schemes to keep depositors from withdrawing cash:

The threshold currently corresponds to 20 times the minimum reserve requirement for the reporting period 20 October 2014 to 19 November 2014 (static component), minus any increase/plus any decrease in the amount of cash held (dynamic component). The change in the amount of cash held is calculated as the difference between the average cash holdings during the most recent reporting period for which the minimum reserve requirement is determined prior to the reference date (cf. section 5 below) and the cash holdings of the corresponding reporting period in a given reference period.

“Libra Paves the Way for Central Bank Digital Currency,” VoxEU, 2019

VoxEU, September 12, 2019. HTML.

Digital currencies involve tradeoffs. Libra resolves them less favorably than other projects, and less favorably than CBDC.

When confronted with the choice between the status quo and a new financial architecture with CBDC, most central banks have responded cautiously. But Libra or its next best replica will take this choice off the table – the status quo ceases to be an option. The new choice for monetary authorities and regulators will be one between central bank managed CBDC on the one hand and – riskier – private digital tokens on the other. Central banks have a strong interest to maintain control over the payment system as well as the financial sector more broadly and to defend the attractiveness of their home currency. Nolens volens, they will therefore introduce ‘Reserves for All’ or promote synthetic CBDCs. In economics, things take longer than one thinks they will, as Rudi Dornbusch quipped, but then they happen faster than one thought they could.

“On the Equivalence of Private and Public Money,” JME, 2019

Journal of Monetary Economics, with Markus Brunnermeier. PDF.

When does a swap between private and public money leave the equilibrium allocation and price system unchanged? To answer this question, the paper sets up a generic model of money and liquidity which identifies sources of seignorage rents and liquidity bubbles. We derive sufficient conditions for equivalence and apply them in the context of the “Chicago Plan”, cryptocurrencies, the Indian de-monetization experiment, and Central Bank Digital Currency (CBDC). Our results imply that CBDC coupled with central bank pass-through funding need not imply a credit crunch nor undermine financial stability.