May 20 New York Federal Reserve President
William Dudley on Tuesday offered a big thumbs-up for one of the
new tools the Fed may use to control rates when it eventually
begins to raise them, and gave a second, even newer tool a
decidedly cooler review.
The comments, at the tail end of a major policy speech in
New York, were Dudley's most detailed yet on the nuts and bolts
of Fed operations once it begins to raise interest rates,
probably some time next year.
Dudley also expressed his preference for continuing to keep
the Fed's $4 trillion-plus balance sheet stable until after the
Fed begins to raise rates, a change to the Fed's current
blueprint for exiting its super-easy policies.
Until now the Fed has said it would first end its current
policy of reinvesting the proceeds of maturing securities in its
portfolio, and then start raising rates.
But that approach, Dudley warned on Tuesday, could cause
financial markets to tighten too early, undercutting the Fed's
Dudley said that "early evidence" shows that the Fed's new
reverse repo facility would "would help strengthen our control
over money market rates."
That's important, he said, because better control over
short-term rates is likely to help the Fed keep a lid on
inflation and inflation expectations. Under the facility, which
the Fed has been testing for a year, banks, dealers, and money
market funds effectively make overnight cash loans to the
central bank, eliminating that liquidity from the system.
By contrast, Dudley suggested the Fed's new term deposit
program, designed to keep cash out of the banking system for
longer than the traditional overnight timeframe, is "less
attractive." The Fed began testing a seven-day term deposit
program this week.
Because the Fed would need to pay higher rates to compensate
firms for locking up their money for longer, Dudley said, it
would be a more expensive option than using the reverse repo
tool. It could also mean the Fed would need to drain most of the
$3 trillion of bank reserves before it could have the control it
needs, he said.
"This could be done of course with effort, but is the effort
worth it?" Dudley said.
Dudley raised a number of issues with the reverse repo
facility, including the possibility of a run on the system in a
crisis. But he suggested such problems could easily be
addressed, for instance by capping overall usage.
The Fed will need to do more testing and analysis before
making any decision, he said. For more on the Fed's new alphabet
soup of short-term rate tools, see
"My goal would be to clarify our intentions later this year,
long before we begin to contemplate raising short-term rates,"
(Reporting by Ann Saphir; Editing by Chizu Nomiyama)