Welcome to “Where is the General Theory of the 21st Century”, an interview series that explore the evolution of the post-Great Recession Macroeconomics.
We are honored to have Jeremy Stein, the Moise Y. Safra Professor of Economics at Harvard University and former member of the Board of Governors of the Federal Reserve, to explain his recent research “The Federal Reserve’s Balance Sheet as a Financial-Stability Tool” (coauthored with Robin Greenwood and Samuel Hanson).
This paper put forth the most widely-accepted argument for the Fed to maintain a sizeable balance sheet going forward. As Prof. Stein explains below, financial market stability could be at risk if too much of the supply of safe assets is from private sector providers. They argue that the financial system would be safer if the government can provide more short-term safe securities to satisfy investors’ demand and crowd-out private sector issuances.
Why do they think it the Fed who issues more reserves for investors? Why can’t Treasury take up the responsibility? More importantly, does it actually mean that the Fed’s balance sheet has to be “sizeable” forever? Prof. Stein will tell us more about all these in the interview below.
Q: EconReporter S: Jeremy Stein
| The transcript is edited for clarity. All mistakes are ours. |
Your argument also suggests a greater role of the RRP (Reverse Repurchase Program) in the Fed’s monetary policy regime. Why do you think the RRP is superior to T-bills and IOER?
S: I think the basic argument is that, somehow, some part of the government should provide something that looks like T-bills. At the highest level, we were just arguing for something like more T-bills provision. That could be done by the Treasury Department. On the one hand, that would be the most direct thing that you could imagine; but on the other hand, the Treasury has been reluctant to issue the volume of T-bills that we might have in mind. Just to give you an example. Roughly speaking, there are about 400 or 500 billion dollars of T-bills out there with the maturity of less than 30 days. If you compare that to the Fed’s balance sheet, which is several trillion dollars, the Fed has been more willing to make short term claims available.
One reason for that may be that the Treasury worries about the “rollover risk.” For example, if there are 2 trillion dollars of 30-day T-bills outstanding, they’ll have to run an auction for 2 trillion dollars every month. They will be worried that auction potentially not going well and not able to roll-over their T-bills.
That same problem does not arise when you are the Fed because the Fed creates the final means of settlement. The Fed creates money. In some sense, they will never have a failure to be able to honor their obligations. That maybe an argument for the Fed doing it as opposed to the Treasury.
Now, if you do have the Fed do it, the Fed can create the reserves or produce the RRP. Reserves in the modern monetary system pay interest so you may think of them as kind of overnight bills. But the interest they pay on reserves can only be received by banks. Or say it a little differently, only banks are allowed to deposit at the Federal Reserve. Compared to the T-bills, which can be broadly-held by anybody in the marketplace; reserves are like a very restricted form of T-bills. So that is less desirable if you’re trying to have this crowding-out effect that we have discussed.
In that sense, RRP is a little closer to what we might think as the ideal, which is the Fed itself issuing some form of bills. It’s closer because money market funds and others can buy and hold Fed’s RRP. From the perspective of having the crowding-out effect, the RRP works better because it can be more broadly-held. But the sort of “high-level thing” is that we would like to have some part of the government creating widely-holdable short-term claims.
What is RRP?
FAQs: Overnight Reverse Repurchase Agreement Operational Exercise – FEDERAL RESERVE BANK of NEW YORK
Working within the Federal Reserve System, the New York Fed implements monetary policy, supervises and regulates financial institutions and helps maintain the nation’s payment systems.