Back in the day, it wasn’t cool to talk about monetary policy at an operational level.
Initially, because monetary policy didn’t matter…
Afterwards, because the central bank only needed to target a monetary aggregate…
Until recently, because the central bank only needed to set “the” interest rate at a “taylored” level…
Back in those days, the central bank would move the discount rate to signal market rates, while creating a demand for reserves using a required reserve ratio and “creating” reserves by open market operations.
Of course, as the “master” of operational monetary policy said, operational frameworks were discussed since the great late Henry Thornton. But nowadays, most academic economists prefer to ignore the “plumbing” behind monetary policy.
When I say “most”, I am not including obviously MMT economists with Scott Fullwiler as a highlight (as well as some other Post-Keynesian economists such as Marc Lavoie) and on the opposite side of the “monetary spectrum”, free banker George Selgin, neo-fisherian Steven Williamson and market monetarist David Beckworth.
In the United States, the Federal Reserve created a deformed floor system in 2008, maybe following the tradition as its late corridor was also a little “twisted”.
As can be seen in the chart below, while “deformed” by some leakiness, the floor system was able to increase market interest rates (EFFR) as the Federal Funds Target range was being lifted. The interest on excess reserves served as a kind of magnet to interbank rates.
But something happened in March 2019…
Even though is not certain what happened (quantitative tightening?, increase in treasury bill issuance?, regulatory shenanigans?), the EFFR unpegged from the IOER. It was something the Federal Reserve was expecting as it had been adjusting the spread between the upper limit of the FFR range and the IOER itself. However when in April, it decreased the IOER by 0,05 p.p. (without changing the FFR target range) and the EFFR didn’t respond as much, it created an expectation to all of us “monetary nerds”.
While most people were focusing on the “Will the Fed reduce the interest rate?” question, we were focusing on the “Will the Fed BE ABLE to reduce the interest rate?” question (to be fair, I must add: while on the current operational framework).
Well.. Hurray for the Federal Reserve, because it was able! The EFFR decreased as much as the IOER, while it still shows a little spread.
So the floor system is alive and kicking (at least for now) and that will force me to reread George Selgin’s book on the desirabilty of a floor system comparing to a corridor, which I will do review here.
To end, one thing I haven’t seen much discussed (and maybe it’s important).
The range of interest rates at which Federal Funds are transacted is getting narrower, as can be seen by the evolution of the light blue line and the orange. The 99th percentile is already inside the FFR range since June. What does this mean? A less assymetric distribution of reserves? (I don’t know…yet)
In the next days, I will publish the post about the transformation ratio and the problems around it.