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Economic SYNOPSES short essays and reports on the economic issues of the day 2008 ■ Number 10 New Monetary Policy Tools? Riccardo DiCecio and Charles S. Gascon S The PDCF accepts a broader range of securities than the TSLF ince the summer of 2007, financial market turmoil has and is a “cash-for-bond” form of lending. As mentioned, to increased the demand for riskless, liquid assets and dried prevent PDCF operations from increasing the monetary base, up liquidity in key markets. Market-determined shortthe Fed offsets the increase with a sale of Treasury securities. term interest rates, normally close to the federal funds rate, In short, the differences in these instruments are types of have risen sharply. The bid-ask interest rate spread—the differacceptable collateral, duration of the loan, which financial ence between what lenders will charge and buyers will pay— institutions have access, and the cost to the borrower. All these has widened. In short, financial institutions have found it actions distribute liquidity to the segments of the financial increasingly difficult to borrow money against collateral. markets facing shortages; but, because they merely change The Federal Reserve has intervened repeatedly to ease liqthe composition of the Fed’s assets, they do not increase the uidity pressures in financial markets. In a sequence of developmonetary base. ments beginning in December 2007, the Fed introduced three On the other hand, this re-allocation of assets may reduce new policy instruments: the Term Auction Facility (TAF), the banks’ demand for excess reserves, and thereby encourage Term Securities Lending Facility (TSLF), and the Primary banks to lend more; this would effectively increase the broader Dealer Credit Facility (PDCF). monetary aggregates that include deposits without changing The TAF is a credit facility that allows depository instituthe monetary base. Therefore, these instruments may indeed tions (e.g., commercial banks) to borrow from the Fed for 28 be tools of monetary policy. ■ days against a wide variety of collateral.1 For the period of the 1 For more details, see David C. Wheelock, “Another Window: The Term Auction loan, this action increases the Fed’s assets and liabilities by the Facility,” Federal Reserve Bank of St. Louis Monetary Trends, March 2008. same amount. (See the examples in black in the table’s second 2 See Federal Reserve Bank of St. Louis Monetary Trends, May 2008, p. 19, for column.) These actions, though, would have the secondary definitions of monetary aggregates. effect of increasing bank reserves and ulti2 mately also the monetary base. In general, the Fed conducts open market operations A Hypothetical Federal Reserve Balance Sheet (OMOs) to counteract unwanted increases (or decreases) in the monetary base; in this OMOs* TAF TSLF PDCF case, it has sold Treasury securities to exactly Treasury securities +1 bil –1 bil –1 bil –1 bil offset this increase. (See the examples in blue Repos (net of reverse repos) in the table’s second column.) TAF credit +1 bil The TSLF permits primary dealers to Discount window credit borrow Treasury securities against other PDCF +1 bil securities as collateral for 28 days. The range Other assets +1 bil of securities that can be used as collateral is Total assets +1 bil 0 0 0 wider than for the TAF. For example, it Reserves +1 bil +1 bil +1 bil includes some mortgage-backed securities. Currency –1 bil –1 bil The TSLF is a “bond-for-bond” form of Total liabilities +1 bil 0 0 0 lending and it affects only the composition of the Fed’s assets without increasing total reserves. NOTE: *The Fed uses open market operations as its standard tool for implementing monetary policy: The first column shows the Fed purchasing $1 billion in Treasuries and thus increasing The PDCF is an overnight loan facility the monetary base by the same amount. that provides funding for up to 120 days to primary dealers in exchange for collateral. Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org
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