Dr. Roberts: “There was a very strange article in the Wall Street Journal that said that the New York Fed, which now has a very elaborate trading floor, had been experimenting with using reverse repos as a way of draining liquidity from the system….
“In other words, the story was saying that looking ahead to the future, when the massive bank reserves that the banks have accumulated from the Fed’s quantitative easing — roughly $3 trillion — come into play, as the economy strengthens, and the banks start lending again to people, inflation could be a problem.
How is the Fed to deal with that? If they (the banks) simply started selling bonds, or selling their portfolio, this could destabilize the system in some way because too much of a rise in interest rates would choke off the recovery. So they (the Fed) were experimenting with a plan to use their portfolio of mortgage-backed financial instruments to do reverse repos in which they would pay the banks interest. And in that way, stop them from lending their excess reserves and causing the money supply in circulation to grow.
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