Tapering, the exit path, and collateral September 21, 2013 at 10:10 am

Peter Stella has an excellent post on VoxEU on the implications of the central bank exit strategy for collateral. What’s nice about this in particular is that Stella understands modern credit creation:

Most credit in the US is created by nonbanks; virtually all bank lending is funded by the creation of liabilities that are not subject to reserve requirements, and central banks do not ration reserves. In fact they take great pains to provide banks with the amount of reserves they desire. Central banks influence credit not by rationing the quantity of reserves but by altering the interest rate that banks must pay to obtain the quantity of reserves they desire.

Stella then points out that the precise exit mechanism chosen from QE has considerable implications for collateral: in particular “reverse-repo has a portfolio effect that [the offer to banks of] term deposits do not”. Indeedy.

2 Responses to “Tapering, the exit path, and collateral”

  1. Would operating a Fed RRF be a tacit admission that no sizeable balance sheet unwind will actually ever happen? And if a Fed reverse repo program for treasuries does alleviate the high quality collateral problem shouldn’t that put downward pressure on market prices for scarce treasuries – on top of negative price pressure from tapering LSAP? Sounds like a lot of balls to juggle especially when they’re all tied to each other.

  2. I certainly agree it is a lot of balls to juggle. What I don’t have a sense for is the balance between collateral demand and potential supply from tapering. If the RRF is meant to balance those factors to keep prices stable well, fine, I guess, but how the FED will manage the program to achieve that goal is mysterious (at least to me).