Volatile money markets this week raised questions about how the Fed will handle future cash shortages
had plenty to fret about as it prepared to discuss policy interest rates on September 17th and 18th. Trade tensions and wilting global growth have seen businesses cut back investment in the second quarter of the year. In manufacturing, production and capacity utilisation have been falling since the end of 2018. Though the Fed has described jobs growth as “solid”, some analysts worry that the labour market is wobbling.
Fortunately, the Fed’s interventions seemed to work. The repo rate returned to its usual level, close to the federal funds rate, which in turn is within the range targeted by the Fed. Even so, the turmoil raised questions about how it plans to handle future cash shortages. The mere prospect of them marks an important shift for America’s financial system. Before the financial crisis the Fed controlled the federal funds rate using a “corridor”, with a ceiling and a floor.
No one knows how much surplus cash banks need to feel comfortable. That depends partly on regulations, which have increased the amount of cash banks must hold as a buffer, but also on business sentiment. Banks’ near-death experience in 2008-09 has left them with a strong desire to hold plenty of extra cash. Economists have attempted to estimate the level at which banks would start to squirm, most coming up with estimates of $1.2trn-1.5trn.
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