Money Market Illiquidity Further Removes A Central Myth

by Jeffrey P. Snider
Alhambra Partners

It might be expected that monetary policy would fail to achieve its goal in attempting to manage the economy when it cannot even meet its own basic technical requirements. The main lever of Fed policy continues to be the federal funds rate even though it is entirely irrelevant, and has been for a long time. There is much more to money markets (plural) than the FOMC considers, a fact proven time and again since August 9, 2007.

In the midst of the panic, for example, the FOMC voted to speed up its interest payments for reserve balances held in custody (electronically). The Financial Services Regulatory Relief Act of 2006 had given the Fed statutory authority to begin the IOR and IOER regime in October 2011, but the conditions of October 2008 warranted, in the view of the Committee, additional “tools.” The immediate problem was one that is still misunderstood today by convention, namely that in the worst parts of the financial crisis the federal funds rate was “too” low; not high.

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