Fed Balance Sheet Mechanics

[Joe Leote]

I published my concept of the four sector model of the US financial system in this paper from 2013:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2257270

This four sector model also applies in my paper for financial instrument generation:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2458563

And in my paper for Treasury finance:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2552733

The Fed blog articles below, which are much easier to comprehend than the notation used in my papers, use the four sector model to demonstrate Fed balance sheet mechanics.

How the Fed Changes the Size of It's Balance Sheet

https://libertystreeteconomics.newyorkfed.org/2017/07/how-the-fed-changes-the-size-of-its-balance-sheet/

How the Fed Changes the Size of It's Balance Sheet: The Case of Mortgage-Backed Securities (MBS):

https://libertystreeteconomics.newyorkfed.org/2017/07/how-the-fed-changes-the-size-of-its-balance-sheet-the-case-of-mortgage-backed-securities/

The Fed's Balance Sheet Runoff and the ON RRP facility:

https://libertystreeteconomics.newyorkfed.org/2022/04/the-feds-balance-sheet-runoff-and-the-on-rrp-facility/

Basically the Treasury issues securities via deficit spending and it guarantees portions of the MBS portfolio issued by the government sponsored entities in the non-bank sector. The money market funds are also in the non-bank sector. The Fed can purchase Treasuries or MBS to increase its assets and liabilities held by banks or non-banks as alternatives to the Treasuries and MBS and it can sell those assets and decrease its liabilities. These operations are used to influence the price of assets and credit market conditions but only do so via changing the liquidity positions of banks and non-bank firms in the money market sector.

Joe

[Joe Leote]

Money market funds and the repo market:

https://www.sec.gov/files/mmfs-and-the-repo-market-021721.pdf

Does inflation cause a run on deposits as retail deposits move to money market funds?

https://youtu.be/xsqduy_d8GQ

If the aggregate bank sector loses deposits, via transfer to money market funds, then either the banks must sell assets to another sector in the four-sector model or the banks must develop non-deposit liabilities as substitutes for the loss of deposits. Some of these non-deposit liabilities are repo liabilities. Also Fed reverse repo seem to be assets of money market funds. If so then these repo liabilities are similar to bank repo liabilities as alternatives to deposit levels in the mix of Fed and bank liabilities.

Joe

[Joe Leote]

Upon further reflection if the Fed is selling Treasuries and/or MBS assets to non-banks, or letting these assets mature and thus runoff the Fed balance sheet, then the related transactions would reduce excess reserves and deposits in the aggregate bank. In other words the decrease in aggregate bank deposits does not always mean a transfer to money market funds. Some of the decrease would be due to the reduction of the Fed balance sheet and some of the decrease would be depositors putting money into money market funds at brokerage firms.

Suppose I transfer deposits to a brokerage account. This is a money market fund managed by the broker or a firm affiliated with the broker. Then if I buy stocks or bonds from you the money market funds move from my money market account to yours so there is no net creation or destruction of MMF simply when investors make investments using their brokerage accounts. Secondary market investments do not create or destroy financial instruments. Instead there is a swap of cash, a swap of floating price assets, and the price of those preexisting assets will average up or average down on the trading volume. If owners of similar assets witness the average up, and mark their assets to market, then they all feel richer; and if owners witness the average down, and mark their assets to market, then they all feel poorer. But everyone cannot trade their floating rate assets for cash at once without help from the Treasury and Fed.

Joe