Recent Updates

  • Australia: CPI (Q2)
  • Australia: CPI (Q2)
  • New Zealand: Employment Indicators (Jun)
  • India: Corporate Bonds (Q2)
  • more updates...

Economy in Brief

Has the Fed Begun a Stealth Tapering/Tightening?
by Paul L. Kasriel  July 6, 2021

The Fed has not announced that it has begun to taper the size of its outright purchases of securities. Nor does it appear that it has. But the Fed has allowed the dollar amount of reserves held by depository institutions to decline or taper. At the same time that the dollar amount of reserves held by depository institutions has declined, the interbank borrowing interest rate on these reserves, the federal funds rate, has risen. Effectively, the Fed has tightened monetary policy in recent weeks.

Plotted in Chart 1 are the point-to-point four-week dollar changes in reserves held by depository institutions at the Fed (the blue line) and securitites held outright by the Fed (the red bars). In the four weeks ended June 30, 2021, securities held outright by the Fed increased $139.7 billion whilst reserves held by depository institutions at the Fed declined by $336.6 billion. When the Fed purchses securities, all else the same, depository institution reserves increase by the same amount as the Fed’s securities purchases. But all else seldom is the same. If the public’s demand for currency increases, this will be a drain on the outstanding amount of reserves. If the Treasury’s cash balances at the Fed increase, this will also will be a drain on the outstanding amount of reserves. If the Fed does not want the amount of outstanding reserves to fall, it engages in operations to replenish these reserves – perhaps adding to its outright holdings of securities or entering into short-term repurchase agreements, which are essentially short-term loans to securities dealers that are collateralized by Treasury securities.

Chart 1

Similiarly, the Fed can reduce the dollar amount reserves outstanding by engaging in short-term reverse repurchase agreements (in the old days, matched sale-purchase operations). In this case, securities dealers lend funds to the Fed on a short-term basis and receive Treasury securities in return. When the dealers transfer funds to the Fed, the outstanding dollar amount of reserves is reduced. Plotted in Chart 2 are the point-to-point four-week dollar changes in the total factors absorbing (draining) reserves, such as increases in currency in circulation and/or reverse repurchase agreements (the red bars) and reverse repurchase agreements alone (the blue line). In the four weeks ended June 30, factors draining reserves totaled $479.2 billion. Reverse repurchase agreements alone drained $588.0 billion. Thus, some other factors, on net, added $108.8 billion of reserves ($588.0 billion minus $479.2 billion). Thus, the dominant factor draining reserves in the four weeks ended June 30 was reverse repurchase agreements. On June 17, the Fed announced an increase in the minimum interest rate it would pay on reverse repurchase agreements from 0.00% to 0.05%. Thus, the draining of reserves via reverse repurchase agreements in recent weeks has been a conscious decision by the Fed.

Chart 2

On June 17, the Fed also raised the interest rate is pays on reserves held by depository institutions from 0.10% to 0.15%. All else the same, this should increase the demand for reserves. At the same time, the Fed has been reducing the supply of reserves. When demand increases and supply decreases, Econ 101 tells us that the price should rise. In the case of reserves, the combination of an increase in their demand and a decrease in their supply would be expected to drive the interest rate on reserves traded in the interbank market, the federal funds rate, higher. Sure enough, that’s what Chart 3 shows. As reserve balances have been declining in recent weeks (the blue bars), the federal funds rate has risen from 0.06% to 0.10%, a whopping 4 basis points (the red line). Nothing to get excited about.

Chart 3

But when you look at what has happened in recent weeks to the growth in the sum of the monetary base (currency plus reserves of depository institutions) and commercial bank credit, the sum being credit created, figuratively, out of thin air, the Fed’s tapering represents a more considerable tightening in monetary policy. Plotted in Chart 4 is the 13-week annualized percent change in the sum of the monetary base and commercial bank credit (the blue line, and blue lines matter), commercial bank credit by itself (the red line) and the monetary base by itself (the green bars). All three have demonstrated slower growth in recent observations. The annualized percent change in the monetary base has slowed from its 2021 high of 80.7% in the 13 weeks ended April 7 to 0.3% in the 13 weeks ended June 23 (negative 8.1% in the 13 weeks ended June 30). The annualized percent change in commercial bank credit has slowed from its 2021 high of 8.9% in the 13 weeks ended May 19 to 5.9% in the 13 weeks ended June 23. And, most importantly, the annualized percent change in the sum of the monetary base and commercial bank credit has slowed from its 2021 high of 23.9% in the 13 weeks ended April 14 to 4.3% in the 13 weeks ended June 23. Not only is the latest 13-week annualized growth of 4.3% in thin-air credit low in relative terms, but the change in the change from its 2021 high, minus 19.6 percentage points, is akin to your vehicle’s automatic collision prevention electronics slamming on the brakes. If I had been “driving” I would have tapped the brakes to gradually slow the degree of accommodation of monetary policy rather than slamming them on.

Chart 4

I have been arguing in recent months that by allowing historically rapid growth in thin-air credit hitherto, the Fed has been sowing the seeds of relatively high future sustained consumer price inflation. If the Fed restricts growth in thin-air credit to 4-1/4% going forward, then the risk of higher sustained inflation is greatly reduced. But that’s a big if. The Fed is under intense pressure, both from within and without, to keep the monetary policy pedal to the metal to mitigate perceived racial/gender wage/income inequities. (In my opinion, these inequities are best addressed by targeted policies such as an expanded/enhanced Earned Income Tax Credit rather than by the blunt instrument of an inflationary monetary policy.) Stay tuned.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
close
large image