Central Banker to the World: Foreign Reserve Management and U.S. Money Market Liquidity

70 Pages Posted: 8 Sep 2022 Last revised: 19 Dec 2022

See all articles by Ron Alquist

Ron Alquist

Financial Stability Oversight Council, U.S. Treasury

R. Jay Kahn

Board of Governors of the Federal Reserve System

Karlye Dilts Stedman

Federal Reserve Bank of Kansas City

Date Written: September 2, 2022

Abstract

We show theoretically and empirically that the dollar’s status as the global reserve currency exposes U.S. money market liquidity to the foreign countries’ real net export shocks. We develop a model in which U.S. money market spreads respond to foreign central banks’ exchange-rate management decisions, which are driven by shocks to their net export position. In response to an increase in export-price volatility, foreign central banks remove liquidity from U.S. money markets and cause spreads to widen by selling Treasuries to supply liquidity to their financial systems. Regression analysis shows that shifts in the central banks’ demand for dollar liquidity related to oil price volatility are associated with elevated spreads in domestic money markets. A one-standard-deviation increase in the demand for dollar liquidity by a central bank in an oil-exporting country leads to a two to six basis point increase in spreads and an average of $3B in Treasury sales. Consistent with our model’s predictions, this higher oil-price volatility also induces deposits with the Federal Reserve to rise.

Keywords: Treasury market, repurchase agreements, market liquidity, exorbitant privilege, fixed exchange rate regime

JEL Classification: E43, G12, G13, G23

Suggested Citation

Alquist, Ron and Kahn, R. Jay and Dilts Stedman, Karlye, Central Banker to the World: Foreign Reserve Management and U.S. Money Market Liquidity (September 2, 2022). Federal Reserve Bank of Kansas City Working Paper No. 22-08, Available at SSRN: https://ssrn.com/abstract=4212685 or http://dx.doi.org/10.2139/ssrn.4212685

Ron Alquist

Financial Stability Oversight Council, U.S. Treasury ( email )

1500 Pennsylvania Avenue, NW
Washington, DC 20220
United States

R. Jay Kahn

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Karlye Dilts Stedman (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

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