The Collateral Supply Effect on Central Bank Policy

36 Pages Posted: 31 Mar 2020 Last revised: 24 Aug 2020

See all articles by Carolyn Sissoko

Carolyn Sissoko

University of the West of England (UWE)

Date Written: August 21, 2020

Abstract

This paper starts by describing the evolution of US money markets over the course of the 1990s and the 2000s. The crucial transition was from an unsecured core money market, the Federal Funds market, to a collateralized market, the repo market. Due to this shift, collateral supply has become an important factor in money market dynamics. Three important implications of this transformation are discussed: First, government debt issues now affect the money market not just due to the need to settle payment for the debt, but also due to the on-going need to fund the carry of the debt. Second, because long-term debt is an important component of collateral supply, any significant increase in long-term rates will have a dramatic effect on the value of the aggregate collateral supply thereby making monetary policy implementation more difficult. Third, the events of March 2020 provide evidence of structural instability in the repo market, and of the problematic nature of a ‘dealer of last resort’ solution. This paper argues that the collateral supply implications of the new money market environment merit careful study, and critically evaluates the dealer of last resort, the proposal for a centralized counterparty for Treasuries, and the proposal for a standing repo facility.

Keywords: money market, repo market, monetary policy, collateral supply, standing repo facility

JEL Classification: E5, N22

Suggested Citation

Sissoko, Carolyn, The Collateral Supply Effect on Central Bank Policy (August 21, 2020). Available at SSRN: https://ssrn.com/abstract=3545546 or http://dx.doi.org/10.2139/ssrn.3545546

Carolyn Sissoko (Contact Author)

University of the West of England (UWE) ( email )

Blackberry Hill Bristol
Bristol, Avon BS16 1QY
United Kingdom

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