Does the Federal Reserve Obtain Competitive and Appropriate Prices in Monetary Policy Implementation?

Abstract

Many of the Federal Reserve's (the Fed's) monetary policy operations involve trading with primary dealers. We find that, for agency MBS, dealers charge 2.5 cents (per \$100 face value) higher selling to the Fed than to non-Fed customers. Controlling for the same dealer, same security, and same trading time, this discriminatory pricing likely arises from dealers' market power rather than inventory cost. Further matching trade size reduces the price differential by more than half, implying that dealers' market power greatly relates to the Fed's purchases in large amounts, whereas the Fed's constrained counterparty choice also plays a noticeable role.

Keywords: Dealer inventory, Discriminatory pricing, Market power, MBS, Monetary policy

JEL Classification: E52, G2, D43