Friday, August 30, 2013

Wenzel versus a Former Plunge Protection Team Member

I have long claimed that Fed chairman Ben Bernanke's introduction of unconventional "tools" to run monetary policy is resulting in even more instability in the economy. There is currently a huge $2 trillion plus  in excess reserves that are hanging over the economy that are likley the result of Bernanke's implementation of IOER. It is unclear if the Federal Reserve will be able to stop this flow of reserves, at some point, into the system, without a dramatic increase in interest rates.

The most recent FOMC minutes show how desperate the Fed is to develop a new tool to deal with the potential outpouring of excess reserves into the system. Here's the key paragraph:
 In support of the Committee's longer-run planning for improvements in the implementation of monetary policy, the Desk report also included a briefing on the potential for establishing a fixed-rate, full-allotment overnight reverse repurchase agreement facility as an additional tool for managing money market interest rates. The presentation suggested that such a facility would allow the Committee to offer an overnight, risk-free instrument directly to a relatively wide range of market participants, perhaps complementing the payment of interest on excess reserves held by banks and thereby improving the Committee's ability to keep short-term market rates at levels that it deems appropriate to achieve its macroeconomic objectives. The staff also identified several key issues that would require consideration in the design of such a facility, including the choice of the appropriate facility interest rate and possible additions to the range of eligible counterparties. In general, meeting participants indicated that they thought such a facility could prove helpful; they asked the staff to undertake further work to examine how it might operate and how it might affect short-term funding markets. A number of them emphasized that their interest in having the staff conduct additional research reflected an ongoing effort to improve the technical execution of policy and did not signal any change in the Committee's views about policy going forward.

What is most startling about this paragraph is the indication by the Fed that it is not entirely clear how this draining mechanism would really work and that the Fed sent the staff to conduct more research on this policy measure.

Bottom line: The Fed really doesn't have a clue as to what to do if the excess reserves come flying out into the system, as the reserves are likely to do at some point.

The reason you aren't hearing more about this in MSM, is because MSM is more confused than the Fed as to how the facility will work. I have seen all kinds of confused reports, including many that have an understanding of how the facility works butt backwards. Indeed,evean a major insider, and former Plunge Protection Team member Pippa Malmgren, didn't seem to understand how the facility worked. She tweeted, yesterday:

I replied to her tweet:

She responded:

Prepare yourself, the Fed is building a new engine reverse mechanism it doesn't really understand, as the ship is sinking.  

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