This post illustrates how banks deposits can be created, transformed, and destroyed. Banks deposits are the numbers in one’s bank account and the most common form of money. They are just digits in a bank’s database that are created when a bank makes a loan or buys an asset, and erased when a loan is repaid or when a bank sells an asset. They can also be transformed into other bank liability types when a …
Category: Advanced Concepts
Published on February 13, 2023 by Joseph Wang Free
QT is incrementally improving the transmission of monetary policy by increasing the share of financial assets sensitive to the Fed’s policy rate. Although the policy rate is approaching 5%, trillions of bank deposits continue to offer around 0%. QT strengthens the transmission of policy by mechanically replacing bank deposits with policy rate sensitive Treasuries, and by forcing banks to compete more aggressively for deposit funding. Both outcomes raise the interest rate on assets held by …
Published on August 22, 2022 by Joseph Wang Free
This post answers four frequently asked questions on the Fed’s balance sheet. The answers to the first two questions will affirm that the Fed is executing QT exactly as promised, even if it may not appear that way. The apparent discrepancy is due to TIPS appreciation and details in MBS settlement mechanics. The answers to the second two questions will show how the Fed balance sheet behaves when the Fed has and negative net interest …
Published on February 7, 2022 by Joseph Wang Free
The Fed’s control over interest rates can also be viewed as control over the quantity of a certain type of money. The mere prospect of rate hikes mechanically reduces the market value of Treasuries, which are widely held as money like safe assets. The declines in value are net losses to the financial system that are also unevenly distributed and cannot be hedged system wide. The losses are further transmitted across asset classes as diversified …
Published on July 26, 2021 by Joseph Wang Free
Domestic businesses have steadily increased their borrowings even though overall bank business lending appears to be declining. In general, businesses seeking to borrow money (bank deposits) have two main sources: banks or the debt capital markets. A bank loan leads to the creation of new bank deposits and increases the overall money supply, while issuing a corporate bond changes the ownership of existing bank deposits. These two markets for money operate under different constraints and …
Published on July 19, 2021 by Joseph Wang Free
RRP take-up reduces liquidity held by banks, but does not change the quantity of liquidity held by Non-Banks. This difference arises from our two tiered monetary system, where banks and non-banks hold different types of money. Banks lose reserves (money for banks) when they settle payments to the Fed on behalf of Non-Bank RRP participants. But from the perspective of Non-Banks, the RRP just replaces bank deposits (money for non-banks) with what are essentially secured …
Published on May 3, 2021 by Joseph Wang Free
QE is intended to put downwards pressure on longer dated yields, but its most obvious impact is on the front end. Repo and short dated bills are pinned around the leaky ON RRP floor, with the zombification spreading up along the bill curve. This outcome stems from of our two-tiered monetary system interacting with the constraints of Basel III. In general, every dollar of QE creates two dollars of money – one dollar of reserves …
Published on April 19, 2021 by Joseph Wang Free
The Fed would like the ON RRP to play a bigger role in its rate control framework, but the ON RRP has been and will always be a very leaky floor for money market rates. From 2016 to early 2018, Treasury bills and agency discount notes consistently traded several basis points below the ON RRP. Today, even tri-party GC repo is occasionally dipping below the floor. The floor will only get leakier as money floods …
Published on March 15, 2021 by Joseph Wang Free
Asset prices rise when there is more money in the system, but you have to understand what ‘money’ is. M1/M2 is not a good measure as it is heavily influenced by Fed policy, which changes the composition of money rather than the overall quantity (see here for a walkthrough). The vast majority of money we come in contact with are bank deposits (the numbers in your bank account). Bank deposits are created by commercial banks …
Published on January 25, 2021 by Joseph Wang Free
There are a few forms of money in the modern financial system, but not all of them are well known. We all know about currency (paper bills) and bank deposits (the numbers in your checking account). If you reading this blog then you also know about central bank reserves (money commercial banks use to pay each other). These are assets that are considered money in large part because they are both risk free and highly …