In addition to the member banks of the Federal Reserve, these financial institutions also include credit unions, savings and loan associations and branches of foreign banks in the United States.
The Federal Reserve requires all financial institutions that absorb depositors' deposits in the United States to deposit some funds in the Federal Reserve to meet the sudden withdrawal needs of depositors.
This fund account is called a reserve account.
According to the requirements of the Federal Reserve, the balance of each institution's reserve account cannot be lower than a certain proportion of its short-term deposits.
This ratio is called the deposit reserve ratio.
If the reserves of financial institutions are lower than the requirements, we must find ways to raise funds to make up for it.
On the contrary, if the reserve is higher than the requirements of the Federal Reserve, the excess is called excess reserve, which can be taken away at any time.
Under normal circumstances, banks with insufficient reserves can issue short-term loans to banks with excess reserves to supplement their reserves.
The interest rate of short-term loans between financial institutions in the market to meet the reserve requirements is called the federal funds rate.
(1) If interest is not paid, the cost of reserves held by banks (if interest is lent) will be very high, and banks will take some unconventional measures to reduce their holdings (for example, transferring deposits to repurchase agreements every night).
If the reserve interest rate is set at a level close to the federal funds interest rate (interbank lending rate), the holding cost will be reduced, and the necessity for banks to conduct unnecessary transactions to avoid these opportunity costs will be greatly reduced.
(2) Setting the reserve interest rate at a fixed level can reduce the impact of interest rate fluctuations on the reserve scale, which is conducive to the implementation of monetary policy.
Paying interest on reserves is equivalent to setting a floor for the federal funds rate:
If the federal funds rate is lower than the excess reserve ratio, banks will be reluctant to lend in the overnight market, but will increase the scale of excess reserves held indefinitely.
For the national debt, a monthly ceiling of 6 billion US dollars will be set at the beginning, and if the maturity exceeds 6 billion US dollars, it will be reinvested, and then the quota will be adjusted every three months in the next year until the quota of 30 billion US dollars is reached; For institutional bonds and MBS, the upper limit is set at $4 billion. If the maturity exceeds $4 billion, it will be reinvested, and then the limit will be adjusted every three months for the next year until it reaches $20 billion.
Historically, the monetary tightening of the Federal Reserve has had a great impact on the global financial market and even triggered many crises.
Because this round of monetary tightening by the Federal Reserve is the superposition of interest rate hike and on-balance-sheet contraction, and the scale of contraction may be very large, it will definitely have a far-reaching impact.
In view of the importance of the Fed's table shrinking, the author noticed the signs that the Fed may start to shrink its table from the end of 20 16, so he immediately carried out relevant research work and consulted a large number of documents.
On the surface, the shrinking of the Fed's balance sheet is a comprehensive issue, but in fact it intersects with many complex issues such as the implementation of the Fed's monetary policy, the evolution of its operational framework, the operation of financial markets, the decision-making mechanism of monetary policy and the coordination with the Ministry of Finance.
Understanding the Fed's contraction table is of great significance to predict the trend of the Fed's monetary policy and the changes in the financial market in the next few years.
To this end, the author will launch a series of research reports on the Fed's shrinking table in the near future, covering the calculation of the size of the Fed's shrinking table, the process prediction, the evolution of the Fed's monetary policy operating framework before and after the crisis, and the impact of shrinking the table. All the reports are the essence of the author's independent original research in the past six months, hoping to help readers understand and judge the Fed's shrinking table.
In this issue, the first article, Final Scale Calculation and Process Prospect of Fed's Table Reduction, was published for the first time. The text is as follows.
Calculation of the size of the Fed's shrinking table
Measuring the scale of the Fed's shrinking table is essentially to measure how large the balance sheet the Fed needs in the future.
The main part of the asset side of the Fed's balance sheet is the SOMA portfolio, and the reduction of the table mainly refers to how to reduce the SOMA portfolio.
Liabilities are mainly reserves, currency and overnight reverse repurchase (on RRP), and capital is almost negligible.
Therefore, the forecast of the size of the Fed's balance sheet is transformed into the forecast of its debt ending size, that is, how much debt the Fed needs.
In other words, how much reserves, money and deposit reserve ratio will the Fed ultimately need?
The main point of this paper is to measure the scale of the Fed's shrinking table from the debt aspect.