The Corporate Law Group

Fed Reverse Repos Fighting Inflation

The Fed is starting to fight inflation. One way it does that is to use repos as a way of draining liquidity off the market and halting the dollars slide. In a Fed repo, the Fed lends money to a selling bank holding Fed securities, against purchase of the securities, and the bank pays it back with interest a day later, receiving the securities back. In a reverse repo the Fed sells a security to a bank and agrees to buy it back later with interest. Reverse repos drain liquidity off the market. The buyer of a reverse repo, a bank, can use the security to enhance its balance sheet for a short term. When the security is repurchased that liquidity is gone. Many see the merit of taking liquidity out of the market. Inflation is too much cash; we already have that. But there are things to be done to keep that excess cash from turning into rising prices, a bad product of inflation. With the Fed unlikely to increase interest rates anytime soon because we are still seen by most as in an intractable recession, the Fed is left with things like reverse repos to try to curb the affects of inflation. However, markets have been scared by reverse repos, seeing any decrease in liquidity as ultimately bad for the economy. We are certainly in uncharted waters. Economists should get some new benchmarks and several theories about inflation will be tested and either confirmed or rejected by the time this economy is sorted out.
Paul Marotta

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