Report: Fed's Exit Strategy May Use Money Market Funds

09-24-2009 • Economic Policy Journal

The Federal Reserve is studying the idea of borrowing from money market mutual funds as part of eventual steps to withdraw stimulus,according to FT.

The Fed would borrow from the funds via reverse repurchase agreements involving some of the huge portfolio of mortgage-backed securities and U.S. Treasuries that it acquired during the financial crisis.

This would drain liquidity from the financial system. But, the money supply isn't growing, so a drain now would be severely deflationary. Either the Fed is contemplating doing this, if banks start to lend against excess reserves, as a back up to Bernanke's plan to control money growth via the interest rate it pays on excess reserves, or this is an insane plan that will monitor the banks balance sheet without taking into account how reserves are impacting the money supply.

I do not see the Fed draining reserves with money supply stable, but if they do, we are going to have one major deflation.