N.Y. Fed Ready to Implement Rate Increases When Ordered to Act – Real Time Economics

The cornerstone of the New York Federal Reserve Bank in New York’s Financial District in March.
Brendan McDermid/Reuters

The man responsible for implementing Federal Reserve monetary policy said Wednesday ongoing uncertainties about how markets will react to rate increases means the central bank will have to be nimble with its interest-rate control programs.

The New York Fed is “is ready to implement policy firming when the [Federal Open Market Committee] determines that economic and financial conditions warrant it,” the bank’s Markets Group head Simon Potter said in the text of speech prepared for delivery before a hometown audience of finance professionals.

“We will be operating in a complex, dynamic, and still-evolving market environment that looks much different from the money markets in which the Fed last operated actively to achieve its interest rate objectives,” he said. “Flexibility is a critical element of the Federal Reserve’s approach to policy normalization,” Mr. Potter said.

While Mr. Potter isn’t responsible for making choices about when to raise rates, his voice is a critical one when it comes to the mechanics of implementation. As the Fed edges toward boosting rates at some point–most officials expect a move off of near-zero rates to happen this year–it has been experimenting with a number of new efforts to control short-term rates in a market flooded with liquidity.

These new tools are largely untested in a real world campaign of rate rises. Mr. Potter, in a highly technical speech, was upbeat and said the Fed has the tools to do the job. But he cautioned unexpected developments could cause the central bank to make further tweaks.

The main tools at issue are the Fed’s power to pay deposit-taking banks interest for money parked on the central bank’s books and its power to pay investment banks and money managers to invest cash at the Fed, as part what are called reverse repurchase agreements. The former tool is designed to define the high end of the range for short-term rates, while the latter is supposed to set a floor. The fed funds rate, the central bank’s traditional short-term rate target, is expected to float within these two rates.

Much of Mr. Potter’s speech was devoted to issues surrounding the reverse-repo program. Fed officials have capped the program at $300 billion a day in a bid to limit any destabilizing influence to financial stability. In the minutes from the Fed’s March meeting, officials said the cap on this program will be boosted at the early stage of a rate-rise campaign before being lowered as rates continue to rise.

Mr. Potter didn’t say what the cap might be boosted to. But he remains positive of the program’s effectiveness, saying it has set a “soft floor” for short-term rates. He also noted changes in the offering rate, done as part of testing, have clearly had an influence on money market rates.

At the start of rate rises, Mr. Potter said the cap on total reverse-repo transactions needs to be high enough to effectively deal with market demand. If demand for reverse repos becomes “volatile,” Mr. Potter said the cap might have to be higher.

But there is still more to learn, the official said. With the new tools, “there are limits to what we can learn from testing. Importantly, we will likely not know the level of support that proximity to the zero lower bound has provided to money market rates until we start to move away from it,” he said.

Mr. Potter also noted the precision with which the Fed controls interest rates should likely improve over time as reserves decline in the financial system.



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15 April 2015 | 10:18 pm – Source: blogs.wsj.com


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