Charles S. Gascon

Riccardo DiCecio

English

Research Papers in Economics

May 2008 MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
S
ince the summer of 2007, financial market turmoil
has increased the demand for riskless, liquid assets
and dried up liquidity in key markets. Market-
determined short-term interest rates, normally close to
the federal funds rate, have risen sharply. The bid-ask
interest rate spread  —the difference between what lenders
will charge and buyers will pay—has widened. In short,
financial institutions have found it increasingly difficult
to borrow money against collateral.
The Federal Reserve has intervened repeatedly to ease
liquidity pressures in financial markets. In a sequence of
developments beginning in December 2007, the Fed intro-
duced three new policy instruments: the Term Auction
Facility (TAF), the Term Securities Lending Facility
(TSLF), and the Primary Dealer Credit Facility (PDCF).
The TAF is a credit facility that allows depository
institutions (e.g., commercial banks) to borrow from the
Fed for 28 days against a wide variety of collateral.1 For
the period of the loan, this action increases the Fed’s assets
and liabilities by the same amount. (See the examples in
black in the table’s second column.) These actions, though,
would have the secondary effect of increasing bank
reserves and ultimately also the monetary
base.2 In general, the Fed conducts open
market operations (OMOs) to counteract
unwanted increases (or decreases) in the
monetary base; in this case, it has sold
Treasury securities to exactly offset this
increase. (See the examples in green in
the table’s second column.)
The TSLF permits primary dealers to
borrow Treasury securities against other
securities as collateral for 28 days. The
range of securities that can be used as
collateral is wider than for the TAF. For
example, it includes some mortgage-
backed securities. The TSLF is a “bond-
for-bond” form of lending and it affects
only the composition of the Fed’s assets
without increasing total reserves.
The PDCF is an overnight loan facility
that provides funding for up to 120 days
to primary dealers in exchange for collat-
eral. The PDCF accepts a broader range of securities than
the TSLF and is a “cash-for-bond” form of lending. As
mentioned, to prevent PDCF operations from increasing
the monetary base, the Fed offsets the increase with a sale
of Treasury securities.
In short, the differences in these instruments are types
of acceptable collateral, duration of the loan, which financial
institutions have access, and the cost to the borrower. All
these actions distribute liquidity to the segments of the finan-
cial markets facing shortages; but, because they merely
change the composition of the Fed’s assets, they do not
increase the monetary base.
On the other hand, this re-allocation of assets may reduce
banks’ demand for excess reserves, and thereby encourage
banks to lend more; this would effectively increase the
broader monetary aggregates that include deposits without
changing the monetary base. Therefore, these instruments
may indeed be tools of monetary policy.
—Riccardo DiCecio and Charles S. Gascon
1 For more details, see David C. Wheelock, “Another Window: The Term Auction
Facility,” Federal Reserve Bank of St. Louis Monetary Trends, March 2008.
2 See page 19 in this publication for definitions of monetary aggregates.
New Monetary Policy Tools?
research.stlouisfed.org
A Hypothetical Federal Reserve Balance Sheet
OMOs* TAF TSLF PDCF
Treasury securities +1 bil –1 bil –1 bil –1 bil
Repos (net of reverse repos)
TAF credit +1 bil
Discount window credit
PDCF +1 bil
Other assets +1 bil
Total assets +1 bil 0 0 0
Reserves +1 bil +1 bil +1 bil
Currency –1 bil –1 bil
Total liabilities +1 bil 0 0 0
NOTE: *The Fed uses open market operations as its standard tool for implementing
monetary policy: The first column shows the Fed purchasing $1 billion in Treasuries
and thus increasing the monetary base by the same amount.

New monetary policy tools?

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New monetary policy tools?

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