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Monetary Policy with Abundant Liquidity: A New Operating Framework for the Fed

Author

Listed:
  • Joseph E. Gagnon

    () (Peterson Institute for International Economics)

  • Brian Sack

    (D. E. Shaw Group)

Abstract

The amount of assets held by the Federal Reserve has dramatically increased since 2009. It recently crossed $4 trillion and will likely peak at about $4.5 trillion. This increase is the result of the Fed's large-scale asset purchase programs, which were intended to support economic growth. However, these purchases have created unprecedented amounts of liquidity in the financial system. Gagnon and Sack doubt that the Fed can smoothly conduct monetary policy along the lines of the previous operating framework in this environment of high liquidity. Instead of reducing bank reserves to achieve a target level for the federal funds rate, they propose a new operating framework that would allow the Fed to maintain an elevated balance sheet along with abundant liquidity in the financial system. They argue that the Fed should set the rate at which it will offer overnight reverse repurchase agreements as its policy instrument, with the interest rate paid on bank reserves set at the same level. The federal funds rate would become just one of the various overnight interest rates determined by the market in the normal transmission of monetary policy.

Suggested Citation

  • Joseph E. Gagnon & Brian Sack, 2014. "Monetary Policy with Abundant Liquidity: A New Operating Framework for the Fed," Policy Briefs PB14-4, Peterson Institute for International Economics.
  • Handle: RePEc:iie:pbrief:pb14-4
    as

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    File URL: https://piie.com/publications/policy-briefs/monetary-policy-abundant-liquidity-new-operating-framework-federal
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    References listed on IDEAS

    as
    1. Seth Carpenter & Selva Demiralp, 2008. "The Liquidity Effect in the Federal Funds Market: Evidence at the Monthly Frequency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(1), pages 1-24, February.
    2. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases," International Journal of Central Banking, International Journal of Central Banking, vol. 7(1), pages 3-43, March.
    3. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
    4. George A. Kahn, 2010. "Monetary policy under a corridor operating framework," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 5-34.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Reverse Repo Risks
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2014-06-26 17:32:41

    Citations

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    Cited by:

    1. christiaan Pattipeilohy, 2016. "A comparative analysis of developments in central bank balance sheet composition," BIS Working Papers 559, Bank for International Settlements.
    2. Bank for International Settlements, 2016. "Macroprudential policy," BIS Papers, Bank for International Settlements, number 86, June.
    3. Philip Turner, 2016. "Macroprudential policies, the long-term interest rate and the exchange rate," BIS Working Papers 588, Bank for International Settlements.
    4. Tamim Bayoumi & Giovanni Dell'Ariccia & Karl F Habermeier & Tommaso Mancini Griffoli & Fabian Valencia, 2014. "Monetary Policy in the New Normal," IMF Staff Discussion Notes 14/3, International Monetary Fund.
    5. Frost, Joshua & Logan, Lorie & Martin, Antoine & McCabe, Patrick E. & Natalucci, Fabio M. & Remache, Julie, 2015. "Overnight RRP operations as a monetary policy tool: some design considerations," Staff Reports 712, Federal Reserve Bank of New York.
    6. Jean-Pierre Landau, 2016. "A liquidity-based approach to macroprudential policy," BIS Papers chapters,in: Bank for International Settlements (ed.), Macroprudential policy, volume 86, pages 147-156 Bank for International Settlements.
    7. Kortela, Tomi, 2016. "A shadow rate model with time-varying lower bound of interest rates," Research Discussion Papers 19/2016, Bank of Finland.
    8. Christiaan Pattipeilohy, 2016. "A comparative analysis of developments in central bank balance sheet composition," DNB Working Papers 510, Netherlands Central Bank, Research Department.
    9. Carpenter, Seth B. & Demiralp, Selva & Senyuz, Zeynep, 2016. "Volatility in the federal funds market and money market spreads during the financial crisis," Journal of Financial Stability, Elsevier, vol. 25(C), pages 225-233.
    10. Naim Cordemans & Ide Stefaan, 2014. "Normalisation of monetary policy : prospects and divergences," Economic Review, National Bank of Belgium, issue iii, pages 29-52, December.
    11. repec:fip:fedlrv:00101 is not listed on IDEAS
    12. Marcelo Rezende & Mary-Frances Styczynski & Cindy M. Vojtech, 2016. "The Effects of Liquidity Regulation on Bank Demand in Monetary Policy Operations," Finance and Economics Discussion Series 2016-090, Board of Governors of the Federal Reserve System (U.S.).
    13. Piazzesi, Monika, 2014. "Should the monetary policy rule be different in a financial crisis?," Journal of Economic Dynamics and Control, Elsevier, vol. 49(C), pages 18-20.
    14. Paul D. Mueller & Joshua Wojnilower, 2016. "The Federal Reserve's Floor System: Immediate Gain for Remote Pain?," Journal of Private Enterprise, The Association of Private Enterprise Education, vol. 31(Summer 20), pages 15-40.
    15. repec:nbb:ecrart:y:2014:m:december:i:iii:p:31-55 is not listed on IDEAS
    16. Keister, Todd & Martin, Antoine & McAndrews, James J., 2015. "Floor systems and the Friedman rule: the fiscal arithmetic of open market operations," Staff Reports 754, Federal Reserve Bank of New York.

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