ON RRP and Stability of the Tri-party Market

Borghan Narajabad
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Borghan Narajabad: Federal Reserve Board

No 1151, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: The Federal Reserve uses the overnight reverse repo (ON RRP) as a monetary policy tool to provide a floor for overnight money market rates. The connection between the ON RRP and tri-party repo market provides an effective tool for interest rate control. But diverting funds away from the tri-party market to the ON RRP could hinder broker-dealers’ funding and cause a problem for the liquidity of various securities markets. The potential negative systemic effect of using the ON RRP could be amplified due to a multiplier effect of cash circulation through the reinvestment of cash collateral by securities lenders in repo. This paper provides a simple competitive search model to shed light on the interaction among the ON RRP eligible and ineligible cash lenders in the tri-party repo market. We use the model to study how the ON RRP rate and capacity affect broker-dealers’ funding. The calibrated model is used to study the tradeoff between the effectiveness of the ON RRP as a monetary policy tool and the potential instability that it can pose.

Date: 2017
New Economics Papers: this item is included in nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:1151

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