Atlanta Fed research offers 17th century lessons for proposed standing repo facility

The Federal Reserve should pay “careful regard” to earlier experiences with implementing a standing repo facility, as managing such facilities during crises can be challenging, warns research published by the Federal Reserve Bank of Atlanta.

Stephen Texas, William Roberds and Charles Kahn analyse a 17^th century Dutch standing repo facility to draw historical lessons for the Fed, which is considering creating a similar facility following September’s repo market shock.

The Bank of Amsterdam, which was founded in 1608 and performed some of the functions of a central bank, designed the facility to overcome three factors that may resonate with market participants today: “An abundance of safe assets in the economy, a strong demand for central bank money, and the unpredictable cost of converting one of these assets into another.”

The authors find that while such a facility can be a success, it can also “fundamentally change the environment” a central bank operates in. During bad times, the facility may face significant and unanticipated shifts in demand, they find.

The Bank of Amsterdam, for example, “belatedly discovered that the short-term options embedded in its facility could be problematic if too many of these were exercised at once”, they write.

The authors also suggest that management of the facility during tail events can be challenging. The bank’s credibility came into question when it decided to lower the collateral standards of the facility during the country’s 1763 crisis, they find.

“Failure to adequately prepare for such events can risk the credibility on which monetary policy depends,” they say.