What Drives U.S. Treasury Re-use?

We study what drives the re-use of U.S. Treasury securities in the financial system. Using confidential supervisory data, we estimate the degree of collateral re-use at the dealer level through their collateral multiplier : the ratio between a dealer's total secured funding and their outright holdings financed through secured funding. We find that Treasury re-use increases as the supply of available securities decreases, especially when supply declines due to Federal Reserve asset purchases. We also find that non-U.S. dealers' re-use increases when profits from intermediating cash are high, U.S. dealers' re-use increases when demand to source on-the-run Treasuries is high, and both types of dealers' re-use can alleviate safe asset scarcity. Finally, we document a sharp drop in Treasury re-use at the onset of the COVID-19 pandemic, with a subsequent reversal after the Federal Reserve's intervention to support market functioning.

US Fed communication will be key to economic prospects

Significance While Chair Jerome Powell cautions that full employment remains some way off, the Fed is considering how and when to wind down its asset purchases. It could give more guidance at the Jackson Hole meeting this month. Impacts The Fed balance sheet has doubled as a share of GDP in 2020/21 and will remain large, possibly only shrinking slowly as the economy grows. Facing criticism of driving inequality, the Fed is unlikely to remove stimulus until gauges such as Black unemployment fall to low levels. Powell’s term as chair ends in February; Joe Biden and Janet Yellen will assess by end-2021 whether he should serve a second term.

Use of the Federal Reserve's repo operations and changes in dealer balance sheets

Before the 2008 financial crisis, the Federal Reserve (Fed) regularly conducted repurchase agreements (repos) in a fairly modest size with primary dealers to adjust the supply of reserves in the banking system and to keep the federal funds rate at the target set by the FOMC. During the economic downturn that followed the financial crisis, the Fed engaged in large scale asset purchases in order to provide additional monetary accommodation, and those purchases significantly increased the supply of reserves and eliminated the need for the Fed to engage in repo operations to increase reserves in the system.

On the money creation approach to banking

We study today’s two-tier money creation and destruction system: Commercial banks create bank deposits (privately created money) through loans to firms or asset purchases from the private sector. Bank deposits are destroyed when households buy bank equity or when firms repay loans. Central banks create electronic central bank money (publicly created money or reserves) through loans to commercial banks. In a simple general equilibrium setting, we show that symmetric equilibria yield the first-best level of money creation and lending when prices are flexible, regardless of monetary policy and capital regulation. When prices are rigid, we identify the circumstances in which money creation is excessive or breaks down and the ones in which an adequate combination of monetary policy and capital regulation can restore efficiency. Finally, we provide a series of extensions and generalizations of the results.

The non-linear effects of the Fed asset purchases

The Federal Reserve responded to the great financial crisis deploying new monetary policy tools, the most notable of which being the expansion of its balance sheet. In a recent paper, Weale, M., and T. Wieladek. 2016. “What Are the Macroeconomic Effects of Asset Purchases?” Journal of Monetary Economics 79 (C): 81–93 show that the asset purchases were effective in stimulating economic activity as well as inflation and asset prices. Here I show that their results are state dependent: large scale asset purchase are effective only when financial markets are impaired. Financial markets are under stress when the effective risk-bearing capacity of the financial sector is drastically reduced, i.e. when the excess bond premium (EBP) of Gilchrist, S., and E. Zakrajšek. 2012. “Credit Spreads and Business Cycle Fluctuations.” The American Economic Review 102 (4): 1692–72 exceed a certain threshold. Using an estimated threshold vector autoregressive model conditional on the EBP regime, I show that an increase in the balance sheet has expansionary effects on GDP and inflation when EBP is high, but not when it is low (as its effects become mostly insignificant). I argue that the high EBP can be interpreted as a proxy of market dis-functioning so that only when this channel of transmission is on, the unconventional policy is particularly effective. This suggests that models of transmission of unconventional policies, based on asset purchases, should focus also on the market functioning channel and not only on the portfolio balance one.

COVID-19 and Financial Markets: A Panel Analysis for European Countries

In order to fight the economic consequences of the COVID-19 pandemic, monetary and fiscal policymakers announced a large variety of support packages which are often unprecedented in size. In this paper, we provide an empirical analysis of the responses of European financial markets to these policy announcements in the spring of 2020. We assemble a granular set of more than 400 policy announcements, both at the national and the European level. We also differentiate between the first announcement in a series of policies and the subsequent announcements because the initial steps were often seen as bad news about the state of the economy. In a panel model, we find that monetary policy, in particular, through asset purchases, is effective in easing the pressure on governmental finances. Stock prices are particularly sensitive to the suspension of the Stability and Growth Pact. Fiscal policy becomes more effective when monetary announcements fall on the same day. We also find sizable cross-border effects of policy announcements.