could you please explain exactly what a coupon pass is
The Federal Reserve maintains the reserves that banks need to make loans. When the Fed increases the reserves banks can make more loans (banks can lend a multiple of the reserve), when they decrease the reserves, banks make fewer loans. Increasing or decreasing the amount of reserves in the system has an indirect effect of increasing or decreasing the money supply. The Fed has two methods for effecting the amount of reserves, one is the coupon pass which is permanent and the other is RPs which are temporary. Here is an excerpt from the Fed site which explains open market operations:
federalreserve.gov
OPEN MARKET OPERATIONS
Open market operations involve the buying and selling of securities by the Federal Reserve. A Federal Reserve securities transaction changes the volume of reserves in the depository system: A purchase adds to nonborrowed reserves, and a sale reduces them. In contrast, the same transaction between financial institutions, business firms, or individuals simply redistributes reserves within the depository system without changing the aggregate level of reserves. When the Federal Reserve buys securities from any seller, it pays, in effect, by issuing a check on itself. When the seller deposits the check in its bank account, the bank presents the check to the Federal Reserve for payment. The Federal Reserve, in turn, honors the check by increasing the reserve account of the seller’s bank at the Federal Reserve Bank. The reserves of the seller ’s bank rise with no offsetting decline in reserves elsewhere; consequently, the total volume of reserves increases. Just the opposite occurs when the Federal Reserve sells securities: The payment reduces the re-serve account of the buyer’s bank at the Federal Reserve Bank with no offsetting increase in the reserve account of any other bank, and the total reserves of the banking system decline. This characteristic—the dollar-for-dollar change in the reserves of the depository system with a purchase or sale of securities by the Federal Reserve—makes open market operations the most powerful, flexible, and precise tool of monetary policy. In theory, the Federal Reserve could provide or absorb bank reserves through market transactions in any type of asset. In practice, however, most types of assets cannot be traded readily enough to accommodate open market operations.
For open market operations to work effectively, the Federal Reserve must be able to buy and sell quickly, at its own convenience, in whatever volume may be needed to keep the supply of reserves in line with prevailing policy objectives. These conditions require that the instrument it buys or sells be traded in a broad, highly active market that can accommodate the transactions without distortions or disruptions to the market itself. The market for U.S. government securities satisfies these conditions, and the Federal Reserve carries out by far the greatest part of its open market operations in that market. The U.S. government securities market, in which overall trading averages more than $100 billion a day, is the broadest and most active of U.S. financial markets. Transactions are handled over the counter (that is, not on an organized stock exchange), with the great bulk of orders placed with specialized dealers (both bank and nonbank). Although most dealer firms are in New York City, a network of telephone and wire services links dealers and customers re-gardless f their location to form a worldwide market. The Federal Reserve’s holdings of government securities are tilted somewhat toward Treasury bills, which have maturities of one year or less (table 3.1). The average maturity of the Federal Reserve’s portfolio of Treasury issues is only a little more than 3 years, somewhat below the average maturity of roughly 5½ years for all outstanding marketable Treasury securities. In the 1980s, the average maturity of the Federal Reserve’s portfolio shortened somewhat, as the Federal Reserve began to emphasize liquidity in managing its portfolio. More recently, the Federal Reserve has slightly lengthened the average maturity of its portfolio.
Techniques of Open Market Operations
Depending on the reserve situation, the Federal Reserve approaches open market operations in one of two ways. When forecasts of the factors that influence reserves indicate that the supply of reserves will probably continue to need adjustment, the Federal Reserve may make outright purchases or sales of securities. If the need is to withdraw reserves, the Federal Reserve may also redeem maturing securities held in its portfolio. (When the Federal Reserve redeems the securities, the Treasury takes funds out of its account to pay the Federal Reserve, leaving fewer reserves in the depository system.) In general, it conducts outright transactions (sales, purchases, and redemptions) only a few times each year, to meet longer-term reserve needs. When projections indicate only a temporary need to alter reserves, either because the technical factor affecting reserves is expected to be reversed or offset or because the near-term outlook for reserves is uncertain, the Federal Reserve may engage in transactions that only temporarily affect the supply of reserves—repurchase agreements, in the case of temporary additions of reserves, and matched sale–purchase transactions, in the case of temporary drains of reserves. These temporary transactions, which are designed to reduce fluctuations in the overall supply of reserves by offsetting the short-term effects of technical factors, are used much more frequently than are outright transactions. Market participants monitor these operations very closely for signs of any change in the underlying thrust of monetary policy.
Repurchase Agreements
When a temporary addition to bank reserves is called for, the Federal Reserve engages in short-term repurchase agreements (RPs) with dealers; that is, it buys securities from dealers who agree to repurchase them by a specified date at a specified price (table 3.3). Because the added reserves will automatically be extinguished when the RPs mature, this arrangement is a way of temporarily injecting reserves into the depository system. Repurchase agreements for the Federal Reserve account may be conducted on an overnight basis or on a so-called term basis. Most term RPs mature within seven days, and dealers sometimes have the choice of terminating the transaction before maturity. The absorption of reserves due to premature terminations by dealers may also suit the needs of the Federal Reserve. Such terminations often occur when the availability of reserves to depository institutions is greater than anticipated, which tends to reduce the borrowing costs that dealers face elsewhere.
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Here is a news site that tracks these operations:
biz.yahoo.com |
