Monday, December 1st, 2008
- In principle the Fed ability to pay interest on excess reserves should keep the FF rate near the target
- In principle, banks have no incentive to lend overnight funds at a rate lower than what can be received from the Fed
- In actuality, several factors have kept the FF rate consistently below target.
- These factors include: the presence in the market of large supplies of funds, notably GSE’s Freddie and Fannie
- As GSEs are not eligible to receive interest on reserves, they are willing to lend overnight Fed Funds below the target rate
- Banks have an incentive to borrow from GSEs and then redeposit the funds at the Fed—this essentially guarantees a profit equal to the spread between the GSEs rate and the rate they receive on excess reserves
- According to the Fed, this type of arbitrage has yet to occur on a ’sufficient scale’– perhaps because banks have yet to adjust their reserve-management practices to utilize this option
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Monday, December 1st, 2008
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Monday, December 1st, 2008
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