On eight Wednesdays per year, the chair of the Federal Reserve Board meets the press after the conclusion of a two-day monetary policy meeting. The central bank chief’s words are closely parsed for economic clues and market-moving projections, but the headline news is always the same: What did the Fed set the benchmark federal funds rate at?
As pre-meeting rate predictions give way to Thursday-morning quarterbacking, the impacts of the Fed decision regarding the overnight bank lending rate begin to slowly work their way through the financial system, affecting Treasury yields, mortgage rates, credit card debt and other savings and borrowing rates.
In the weeks following the Fed rate decision, members of the Federal Open Market Committee (FOMC) that sets interest rates are often asked to appear at economic forums or on financial news programs to explain their monetary stances. But Dallas Fed President Lorie Logan took a different approach during a speech Thursday at a Federal Reserve Bank of Richmond workshop.
Logan, who serves as an alternate FOMC member, proposed scrapping the federal funds rate altogether as the central bank’s operating target rate. In its place, she suggested the tri-party general collateral rate (TGCR), a lesser-known metric that measures rates on overnight repurchase agreements (repos) used in the tri-party market that are backed by Treasury securities.
Logan pointed out that the fed funds rate wasn’t adopted as the Fed’s target rate until the early 1980s, when “changes in the regulation of interest rates on bank accounts disrupted the relationship between economic activity and monetary aggregates.” In the ’70s, the Fed sometimes allowed that rate to swing by several hundred basis points in a single day as it aggressively tried to attack runaway inflation.
And it wasn’t until the 1990s that the FOMC began issuing post-meeting statements, Logan added, after which the fed funds rate became a digestible way for financial markets and the public to gauge the central bank’s current monetary policy stance. But “a lot has changed since then,” she remarked, “and the fed funds target is showing its age.”
A fragile connection
Many people think of money markets as those boring, highly liquid mutual funds that earn interest in a brokerage account or at a local bank.
But money markets also refers to the global network for the lending and borrowing of short-term securities with maturities of a year or less.
Logan argues that money markets have evolved since the fed funds rate became the Fed’s public-facing benchmark several decades ago. In the aftermath of the 2008 financial crisis, “fed funds is no longer where banks normally look to lend or borrow short-term cash,” she says.
Instead, Logan believes “the center of gravity in U.S. money markets now lies in repo markets, where loans are secured by Treasury securities or other collateral.” She cites overnight and open-dated repos averaging more than $4.5 trillion in volume per day versus fed funds volume of just over $100 billion a day.
Logan thinks the TGCR that tracks repos on Treasury-secured assets would provide a better benchmark rate for the Fed. The “connection is fragile” between the fed funds rate and other markets, she believes, while the TGCR involves “a large number of participants,” is “calculated with a robust methodology” and “transmits well across money markets.”
To be clear, Logan isn’t arguing that the current system is broken. She still believes the fed funds rate “gives us a good gauge of broader monetary conditions, and controlling fed funds still influences broader monetary conditions.”
But she cautions that “if transmission between fed funds and other money markets ever broke down, we’d need to quickly find a replacement target, and I don’t think making important decisions under time pressure is the best way to promote a strong economy and financial system.”
