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

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 cents (per $100 face value) higher selling to the Fed than to non-Fed customers. Controlling the same dealer, same security, and same trading time, this discriminatory pricing arises likely from dealers' market power rather than inventory cost. Further controlling the same trade size reduces the price differential considerably, implying that dealers' market power mainly relates to the Fed's rapid purchases in large amounts, though the Fed’s limited counterparty choice (primary dealers exclusively) also plays some role.

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

JEL Classification: E52, G2, D43