Fed Should Buy $250 Bln in Treasuries, Ex-Officials Suggest
Former central bankers also called on the Fed to abandon its federal funds rate target and adopt the repo rate.
(Bloomberg) -- The Federal Reserve should consider increasing its balance sheet by $250 billion over the next two quarters through outright purchases of Treasury securities to help diminish the risk of future money market turmoil, two former U.S. central bank officials said.
In a blog posting on the Peterson Institute for International Economics’ website, Joseph Gagnon and Brian Sack write that “a case can be made’’ for such a move to build up a buffer of bank reserves at the Fed.
After the purchases are completed, “the Fed should continue to grow its balance sheet as needed to expand reserves in line with nominal GDP,’’ or gross domestic product, said Gagnon, now a senior fellow at Peterson, and Sack, currently director of global economics for the D.E. Shaw Group.
Last week’s turmoil in the money markets focused attention on the level of bank reserves and whether the Fed went too far in shrinking its securities holdings. Its balance sheet now totals $3.8 trillion, down from a high of $4.5 trillion in January 2015.
New York Fed President John Williams said on Monday that policy makers will assess the implications of recent market moves “for the appropriate level of reserves and time to resume organic growth of the Federal Reserve’s balance sheet.’’
The New York Fed has conducted a series of repo auctions to provide liquidity to money markets. Primary dealers on Thursday oversubscribed its operation for term repurchase agreements, even after the bank doubled the maximum size of the offering to $60 billion.
In a Sept. 23 note, Wrightson ICAP LLC chief economist Lou Crandall reckoned that such an organic approach would result in the Fed increasing its purchases of Treasuries by roughly $15 billion per month.
Last week’s turbulence in the repurchase agreement market indicates that the Fed’s operating framework “is not as resilient as it could be,” according to Gagnon and Sack.
“Volatility in this market threatens the functioning of markets more broadly and could ultimately hurt the economy,’’ they said.
They urged the Fed to adopt a standing fixed-rate repo facility under which banks and other selected financial institutions could borrow from the central bank, arguing that would provide a “guard rail” against unexpected market developments.
Fed policy makers discussed the possibility of establishing such a facility when they met in June, but reached no conclusions, according to the minutes of that gathering.
Gagnon and Sack also called on the central bank to abandon its federal funds rate target and adopt the repo rate -- as measured by the secured overnight financing rate –- as its objective instead.
“The Fed should be explicit about its desire to control the repo rate,” they said.
Sack was formerly an executive vice president at the Federal Reserve Bank of New York, where he served as the head of the Markets Group and the manager of the System Open Market Account for the Fed from 2009 to 2012.
Before joining Peterson in 2009, Gagnon was visiting associate director for the Fed’s Division of Monetary Affairs. He also served in a variety of other posts at the central bank and the Treasury Department in a public sector career that began in 1987.
To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net
To contact the editors responsible for this story: Margaret Collins at mcollins45@bloomberg.net, Vince Golle, Alister Bull
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