By Bilal Hafeez 08-10-2019

Don’t Fear the Repo (Grant’s Current Yield, 25 min listen)

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(You can listen to the podcast by clicking here)

George Selgin from the Cato Institute reviews the recent repo rate surge and argues that the private repo market’s inability to accommodate banks’ demand for excess reserves was the root cause. By paying interests on excess reserves, the Fed essentially encouraged and necessitated banks holding large amounts of them. Selgin then addresses the excessive collaterals in the market and parallels them with too much debt in the money market. He also goes into why the Fed would introduce additional QE to address the problem and how the Fed should address the redistribution problem that doing so would bring – that is, avoiding having too many reserves becoming concentrated in the largest banks. Finally, he agrees that each time a new problem emerged in the money market, it appeared as a result of the Fed’s previous attempt to solve a precedent market problem.

Why does this matter? The ‘fixes to fixes to fixes’ problem from central banks is a dilemma without quick solutions in sight. It seems like trying to manually strike the market equilibrium and stop an unwanted chain reaction from happening is next to impossible. However, if the Fed does introduce a new round of QE to handle the liquidity issues and we anticipate another havoc in the interest rate markets and if growths are still going to pick up in real terms in the long run. A recent BIS report also confirmed that the rapid bank balance sheet expansion is highly distortionary.