The Federal Reserve Bank of New York posted "How the Fed's overnight Reverse Repo Facility Works" on its Liberty Street Economics blog. They write, "Daily take-up at the overnight reverse repo (ON RRP) facility increased from less than $1 billion in early March 2021 to just under $2 trillion on December 31, 2021. In the second post in this series, we take a closer look at this important tool in the Federal Reserve's monetary policy implementation framework and discuss the factors behind the recent increase in volume. In yesterday's post, we presented a stylized view of the Fed's implementation framework for monetary policy, in which (i) the Federal Open Market Committee (FOMC) communicates the stance of monetary policy through a target range for the federal funds rate, (ii) interest on reserve balances (IORB) is a key tool, and (iii) an ample supply of reserves ensures that the interest rate paid on banks' reserve balances maintains the effective federal funds rate (EFFR) within the target range. However, in the United States, banks are only a part of the money market ecosystem -- nonbank financial institutions make up a significant share of lending activity." The piece continues, "As a result, the FOMC employs another tool called the ON RRP facility, which is available to a wide range of money market lenders. This facility is particularly important for monetary policy implementation in periods when reserves are elevated. As reserves grow, banks' willingness to take on additional reserves diminishes, and they reduce the rates they pay for deposits and other funding. In this environment, market rates trade below the IORB rate because nonbank lenders are willing to lend at such rates. For example, the Federal Home Loan Banks (FHLBs), which are important lenders in the fed funds market and not eligible to earn IORB, are willing to lend at rates below the IORB rate rather than leave funds unremunerated in their accounts at the Fed. To provide a floor under the fed funds rate, the FOMC introduced the ON RRP facility.... In concept, the ON RRP facility acts like IORB for a set of nonbank money market participants. Through the ON RRP facility, eligible institutions -- money market funds, government-sponsored enterprises, primary dealers, and banks -- can invest overnight with the Fed through a repurchase agreement (repo). By setting the ON RRP rate, the FOMC establishes a floor on the rates at which these institutions are willing to lend to other counterparties. The floor improves these institutions' ability to negotiate rates on private investments above the ON RRP rate and provides an alternative investment when more attractive rates are not available. In periods when the EFFR is close to or above the IORB rate, we would not expect the ON RRP facility to see much take-up as money market participants have access to alternative investments at more favorable rates.... In contrast, when reserves are plentiful and the EFFR moves closer to the bottom of the fed funds target range, the rate offered at the ON RRP facility becomes more attractive relative to alternative investments and we would expect to see an increase in take-up at the ON RRP facility.... At such times, the ON RRP facility is particularly important for the control of the EFFR. This is indeed what happened from 2013 through 2017, and in 2021 as well. As reserves have reached unprecedented levels over the last year, so has take-up at the facility." The blog adds, "An ON RRP transaction -- which is economically similar to a secured loan -- does not change the size of the Fed's balance sheet but does shift the composition of the Fed's liabilities. For instance, when a money market fund reduces overnight deposits with a bank and directs those funds to the ON RRP facility, the increase in the ON RRP facility decreases reserve balances held by banks at the Fed. The ON RRP facility, thus, allows the Fed's liabilities to be more broadly distributed among money market participants. To circle back to the beginning of the post, in the recent environment of abundant reserves, the ON RRP facility is working as expected. It is providing a floor under the fed funds rate and moderating the growth in reserve balances as the Fed continues to provide support to the U.S. economy."

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