Introduction to Monetary Policy
The Federal Reserve Bank of Dallas President, Lorie Logan, recently suggested that the central bank should modernize its approach to managing money market conditions to achieve its monetary policy objectives. This proposal comes as the central bank is facing a challenging period in keeping its interest rate target in line.
The Need for Change
Logan believes that the time has come for the Federal Open Market Committee (FOMC) to prepare to target a different short-term interest rate. The current practice of targeting the federal funds lending market needs to shift, with the Fed instead managing liquidity to control the trading level of the tri-party general collateral rate (TGCR). This change is technical and does not have implications for monetary policy broadly speaking.
Why Target the TGCR?
The TGCR is considered the best option because that market is very active, and the Fed’s existing tools already provide effective control of the rate. In contrast, targeting fed funds currently provides effective control of broader monetary conditions, but the connections are fragile and could break suddenly. Logan suggests that the FOMC should take that risk off the table by targeting the TGCR.
Current Challenges
The central bank is about to face a challenging period of keeping its interest rate target in line. At the end of this month, liquidity conditions are likely to temporarily tighten, causing cash to flood into Fed liquidity facilities. Additionally, the ongoing drawdown of the Fed’s balance sheet could bring unexpected turbulence to money markets.
How the Fed Currently Manages Interest Rates
The Fed seeks to achieve its employment and inflation mandates by shifting the setting of the federal funds rate, which is currently between 4% and 4.25%. This rate is managed by two other rates, one that pays banks for reserves and another that pays money market funds for cash. These two rates bound the high and low ends of the fed funds range.
Issues with the Current System
The federal funds market, where banks lend and borrow reserves, has dried up amid the central bank’s flooding markets with reserves as it navigated the financial crisis and the COVID-19 pandemic. Some have argued that the Fed’s administered rates that guide the funds rate should become the formal targets, but Logan pushed back on that, saying those two rates "will always be exactly what the Fed wants them to be, regardless of market conditions.”
Benefits of Targeting the TGCR
Targeting the TGCR would still allow for some movement in that rate, and the central bank would not need to provide "pinpoint control to the basis point." Logan believes that it would be perfectly fine for the TGCR to move up and down from day to day, much as it has for many years. This approach would allow the Fed to maintain rate control with its current simple and efficient tools, without large, frequent, or complex operations.
Conclusion
In conclusion, the Federal Reserve Bank of Dallas President, Lorie Logan, has suggested that the central bank should modernize its approach to managing money market conditions by targeting the tri-party general collateral rate (TGCR). This change is technical and would allow the Fed to maintain effective control of monetary conditions while reducing the risk of sudden changes in the federal funds market. By being ahead of the curve and making this change when markets are functioning smoothly, the Fed can ensure a smoother transition and minimize potential disruptions to the economy.
