Friday, October 31, 2014

The Fed's Term Deposit Facility comes of age

As discussed earlier (see post), the US monetary base had stopped growing in July and is now in fact lower than it was over the past few months.

Given that the securities purchases continued through October, the flattening of the monetary base was the result of the Fed "draining" some of the reserves. Most of that was due to the reverse repo program (RRP) as well as the Term Deposit Facility (TDF). The TDF is a tool that is quite similar to what the ECB used to sterilize its securities purchase program (SMP) - an initiative the European Central Bank recently terminated (see story). Here is how the Fed describes the purpose of this facility.
Federal Reserve Bank of Philadelphia: - In 2010, the Federal Reserve put in place another method for managing reserves, the Term Deposit Facility (TDF). The TDF works in reverse of the Term Auction Facility [see post from 2009]. In the TDF, the Fed is offering term deposits on an auction basis. When a depository institution purchases a term deposit from the Federal Reserve, the funds are removed from its reserve account at a Federal Reserve Bank, thereby reducing the amount of bank reserves for the specified term of the deposit. Both paying interest on reserves and the TDF provide the Fed with strong tools for reducing aggregate bank reserves and will be very useful when it comes time to tighten monetary policy and reduce the size of the Fed’s balance sheet.
The TDF is still in "experimental" stages but the Fed has recently ramped it up (h/t Econ Brothers) - which is part of the reason for the lower monetary base.

The latest version is a seven-day deposit with an early withdrawal penalty. While the TDF drains reserves, the primary goal of the program is to give the Fed another tool to control short term rates. In fact the TDF could potentially become a more actively used program than the RRP.

In addition to the Fed Funds Target Rate for overnight interbank lending (which has declined in recent years), the the Fed will be setting the rate it pays on excess reserves (IOER), on the reverse repo (RRP), and also on these term deposits (TDF). The rate change announcement will therefore be a complex set of procedures going forward.

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