By Michael S. Derby
(Reuters) -Federal Reserve Bank of Dallas President Lorie Logan said Thursday the time has come for the central bank to modernize how it manages money market conditions to achieve its monetary policy objectives.
To do this, Logan said the central bank’s long-standing 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, or TGCR, given the vibrancy of that
market.
“The time has come for the [Federal Open Market Committee] to prepare to target a different short-term interest rate,” Logan said in the text of a speech prepared for delivery before an event at the Richmond Fed.
Logan cautioned that such a change is technical and does not have implications for monetary policy broadly speaking. The Dallas Fed president managed the implementation of monetary policy at the New York Fed before she took helm of the regional Fed bank.
The official said targeting the TGCR is the “best” option because that market is very active and “the Fed’s existing tools already provide effective control” of the rate. As for the status quo, “while targeting fed funds currently provides effective control of broader monetary conditions, the connections are fragile and could break suddenly. The FOMC should take that risk off the table,” Logan said.
The central banker’s call for reform of how the Fed manages its rate target comes as 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 in such a way cash will flood into Fed liquidity facilities, which are in place to help keep money market rates in line with the levels set out by the FOMC.
Beyond that, the ongoing drawdown of the Fed’s balance sheet could bring unexpected turbulence to money markets.
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As it now stands, the Fed seeks to achieve its employment and inflation mandates by shifting the setting of the federal funds rate, which is now at between 4% and 4.25% after last week’s quarter percentage point rate cut. That 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.
The challenge for the Fed is that 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.” Logan also said there are issues with the Fed trying to manage a rate based on a constellation of other money market rates.
Logan said 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.”
“It would be perfectly fine, in my view, for TGCR to move up and down from day to day, much as it has for many years,” Logan said. “After all, the target range is 25 basis points wide,” she said, adding “a tolerance for modest volatility would allow us to maintain rate control with our current simple and efficient tools, without large, frequent or complex operations.”
Logan also said the evolutions in money market conditions are likely to force a shift at some point, and it would be better to be ahead of the curve rather than forced into action.
“If the target rate must change, the best time for a change would be when markets are functioning smoothly and market participants can have plenty of advance notice,” she said.
(Reporting by Michael S. Derby; Editing by Anna Driver)
