Navigating the Labyrinth: Demystifying Corridor and Floor Systems in Monetary Policy What is the corridor system? What is the floor system? What are the differences between two system? #Fed #Corridor
I enjoyed your post. Please keep generating more content! I have a question about the RRP rate. What's the mechanism that prevents the funds rate from declining below the RRP rate? How exactly does it serve as the lower limit for the funds rate? I understand that a bank wouldn't lend reserves at a rate that's below IORB, which creates the upper limit, but don't understand completely how the RRP rate creates the lower limit.
In this environment, market rates trade below the IORB rate because nonbank lenders are willing to lend at such rates. For example, the Federal Home Loan Banks (FHLBs), which are important lenders in the fed funds market and not eligible to earn IORB, are willing to lend at rates below the IORB rate rather than leave funds unremunerated in their accounts at the Fed. To provide a floor under the fed funds rate, the FOMC introduced the ON RRP facility.
The FHLBs are eligible counterparties for the ON RRP facility, so they can lend to the Fed at the ON RRP rate. Therefore, they will only lend in the funds market at a rate that's greater than the ON RRP rate. Do I understand that correctly?
I enjoyed your post. Please keep generating more content! I have a question about the RRP rate. What's the mechanism that prevents the funds rate from declining below the RRP rate? How exactly does it serve as the lower limit for the funds rate? I understand that a bank wouldn't lend reserves at a rate that's below IORB, which creates the upper limit, but don't understand completely how the RRP rate creates the lower limit.
Dear TD, this article explains your question https://libertystreeteconomics.newyorkfed.org/2022/01/how-the-feds-overnight-reverse-repo-facility-works/
In this environment, market rates trade below the IORB rate because nonbank lenders are willing to lend at such rates. For example, the Federal Home Loan Banks (FHLBs), which are important lenders in the fed funds market and not eligible to earn IORB, are willing to lend at rates below the IORB rate rather than leave funds unremunerated in their accounts at the Fed. To provide a floor under the fed funds rate, the FOMC introduced the ON RRP facility.
The FHLBs are eligible counterparties for the ON RRP facility, so they can lend to the Fed at the ON RRP rate. Therefore, they will only lend in the funds market at a rate that's greater than the ON RRP rate. Do I understand that correctly?
Exactly.
Thank you for the explanation, Engin!