Marco Cipriani, James Clouse, Lorie Logan, Antoine Martin, and Will Riordan
In a Liberty Street Economics post that appeared yesterday, we described the mechanics of the Federal Reserve’s balance sheet “runoff” when newly issued Treasury securities are purchased by banks and money market funds (MMFs). The same mechanics would largely hold true when mortgage-backed securities (MBS) are purchased by banks. In this post, we show what happens when newly issued Treasury securities are purchased by levered nonbank financial institutions (NBFIs)—such as hedge funds or nonbank dealers—and by households.
The actual evolution of private-sector balance sheets could involve adjustments similar to those outlined in the various scenarios described in our previous post on balance sheet runoff and in this one. These scenarios indicate that the adjustments in private-sector balance sheets can be quite complex, involving flows across markets and institutions that exceed the dollar value of the net increase in securities holdings by the private sector. Also, whether the adjustment on the Fed’s balance sheet happens through a reduction of reserves or of ON RRP investment depends on the type of securities that the Treasury issues (that is, whether MMFs can hold these securities), as well as on the relative return on different types of money market instruments.
The full article is available at https://libertystreeteconomics.newyorkfed.org/2022/04/the-feds-balance-sheet-runoff-the-role-of-levered-nbfis-and-households/