The Fed ' s LCR Reserve Requirement: An Ace up Its Floor-System Defense Sleeve

Among many other advantages it enjoys when it comes to influencing the course of monetary reform, the Fed has that of being able to shift the constraints that determine whether a proposed reform is or isn ’t possible. If existing constraints don’t stand in the way of some reform Fed officials would rather not see happen, they can always put up a new one, tailor-made for the purpose.The Fed seems prepared to do just that as part of its campaign to keep the “floor” system of monetary control it set-up in October 2008 around for good. Considering the floor system’s many disadvantages compared to a “corridor” system, should the plan work we may all live to regret it. Those disadvantages include:A considerable increase in the share of financial-institution intermediated credit that gets shunted into the Fed ’s coffers;A moribund interbank fed-funds market, with correspondingly reduced incentives for interbank risk monitoring;A less-reliable monetary control mechanism, as evidenced by the failure of changes in the IOER rate to result in like changes in market-determined interest rates; andA Fed balance sheet made ripe for political abuse by the fact that it ’s size is no longer a determinant of the stance of monetary policy.[1]For the most part, Fed officials have tried to justify the floor operating system by ignoring its shortcomings whilst harping on its supposed advantages, including the fact thatit enhances banks ’ liquidity by encouraging them to stockpile...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs