Working Paper: NBER ID: w29090
Authors: Adam Copeland; Darrell Duffie; Yilin Yang
Abstract: The Federal Reserve's "balance-sheet normalization," which reduced aggregate reserves between 2017 and September 2019, increased repo rate distortions, the severity of rate spikes, and intraday payment timing stresses, culminating with a significant disruption in Treasury repo markets in mid-September 2019. We show that repo rates rose above efficient-market levels when the total reserve balances held at the Federal Reserve by the largest repo-active bank holding companies declined and that repo rate spikes are strongly associated with delayed intraday payments of reserves to these large bank holding companies. Intraday payment timing stresses are magnified by early-morning settlement of Treasury security issuances. Substantially higher aggregate levels of reserves than existed in the period leading up to September 2019 would likely have eliminated most or all of these payment timing stresses and repo rate spikes.
Keywords: Federal Reserve; repo market; liquidity; reserve balances
JEL Codes: G12; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reduction in aggregate reserves (E20) | Increased repo rate distortions (E43) |
| Decline in total reserve balances held by largest repo-active BHCs (G28) | Repo rates rose above efficient market levels (E43) |
| Delayed intraday payments of reserves (E49) | Repo rate spikes (E43) |
| Higher aggregate levels of reserves than those existing before September 2019 (E19) | Mitigated stresses and spikes (E32) |