Passthrough Efficiency in the Fed’s New Monetary Policy Setting (Preliminary)

We show how the current institutional setting of U.S.-dollar money markets limits the passthrough effectiveness of the Federal Reserve’s monetary policy. We focus on frictions associated with imperfect competition, regulation, infrastructure, and other forms of institutional segmentation within money markets. We model how imperfect competition is exacerbated by costs to cash investors associated with search and information attention. We show that passthrough is further dampened by the supplementary leverage ratio (SLR) rule, which distorts repo intermediation incentives for bank-affiliated securities dealers, and the Liquidity Coverage Ratio (LCR) rule, which can inhibit the creation of short-term bank liabilities, also reducing passthrough effectiveness. We explain how these impediments to passthrough efficiency are mitigated by the Fed’s reverse repurchase (RRP) facility, but mainly through the disintermediation of banks, which has some costs that we discuss.