So aside from loan repayments outpacing new loans, QT destroys deposits because the Treasury is still having to fund principal payments to the Fed (including selling to non-banks) whilst the Fed isn't reinvesting all of the proceeds (fewer payments to non-banks)? I.E. deposits decline because of this new mismatch in transactions taking place between non-banks and the Treasury/Fed?
The Fed is draining reserves. That appears to be mainly via using the repo facility as opposed to selling, but it has the same effect if the ultimate counterparties are not banks. What the Treasury is doing isn’t material.
Perhaps I was unclear, I'm asking about the effect of QT on bank deposits specifically, and what actually causes the aggregate 'stock' of deposits to decline. I believe I understand the mechanics of how QE creates deposits, but the reverse is less clear to me.
Deposits decline because the non-bank sector is trading deposit assets for financial claims on the general government (either Treasury bonds/bills or repos) by interacting with the Fed. The Treasury is not directly involved in those transactions (other than supplying the assets).
Hi Brian, when you say a bank buys UST by swapping them for reserves, do you mean the bank first creates a deposit to buy the UST, and then the Treasury transfers that deposit to the TGA, resulting in a swap by the bank (UST for reserves)? I mean, if a bank buys a corporate bond it creates a deposit, end of story right?
(I just noticed that I only covered banks selling UST’s, and forgot to note that QT is the reverse.)
It might be that I’m missing details, but in all these Treasury transactions between the gov’t and the private sector (including auctions), primary dealers are dealing with the Fed. Payments to/from the Fed destroy/create reserves, the Fed then passes along the payment to the Treasury. If the bank that is ultimately changing its balance sheet does not have a primary dealer subsidiary, it will be using the primary dealer as an intermediary. I am used to the Canadian system where the MoF banks at the central bank, not sure how the Treasury uses the TGA.
A bank that buys anything either sends reserves to the recipient’s bank (which adds reserves and a corresponding deposit) or adds a deposit if the recipient banks with that bank itself. The banking system in aggregate adds a deposit, and reserves are unchanged. The exception is where it is dealing with the gov’t, as transfers there create or destroy reserves in the banking system.
So you agree that when a bank buys a UST at first a deposit is created and M2 goes up.
Next, Treasury can decide to transfer that deposit to its TGA - a reserve and deposit are withdrawn from the banking system, M2 goes down - and then Treasury can spend from its TGA - a reserve and deposit enter the banking system, increasing M2.
Sorry, maybe we talk different languages but I like to get a few facts straight.
As I noted, not if the banking system is dealing with the Fed, which is what happens with QT. The bank dealing with the Fed sends reserves, destroying them. The Fed does not leave money on deposit at private banks. What happens with the TGA is a separate issue.
Banks only create/destroy deposits when dealing with the private sector. The non-bank entity exchanges deposits vs. bonds on its balance sheet, the banking sector does the balancing transactions.
As far as I can tell it doesn't really matter if the Fed sells its UST or just lets them mature, since the DoT issues and sells new USTs to replace maturing ones.
So aside from loan repayments outpacing new loans, QT destroys deposits because the Treasury is still having to fund principal payments to the Fed (including selling to non-banks) whilst the Fed isn't reinvesting all of the proceeds (fewer payments to non-banks)? I.E. deposits decline because of this new mismatch in transactions taking place between non-banks and the Treasury/Fed?
The Fed is draining reserves. That appears to be mainly via using the repo facility as opposed to selling, but it has the same effect if the ultimate counterparties are not banks. What the Treasury is doing isn’t material.
Perhaps I was unclear, I'm asking about the effect of QT on bank deposits specifically, and what actually causes the aggregate 'stock' of deposits to decline. I believe I understand the mechanics of how QE creates deposits, but the reverse is less clear to me.
Deposits decline because the non-bank sector is trading deposit assets for financial claims on the general government (either Treasury bonds/bills or repos) by interacting with the Fed. The Treasury is not directly involved in those transactions (other than supplying the assets).
Hi Brian, when you say a bank buys UST by swapping them for reserves, do you mean the bank first creates a deposit to buy the UST, and then the Treasury transfers that deposit to the TGA, resulting in a swap by the bank (UST for reserves)? I mean, if a bank buys a corporate bond it creates a deposit, end of story right?
(I just noticed that I only covered banks selling UST’s, and forgot to note that QT is the reverse.)
It might be that I’m missing details, but in all these Treasury transactions between the gov’t and the private sector (including auctions), primary dealers are dealing with the Fed. Payments to/from the Fed destroy/create reserves, the Fed then passes along the payment to the Treasury. If the bank that is ultimately changing its balance sheet does not have a primary dealer subsidiary, it will be using the primary dealer as an intermediary. I am used to the Canadian system where the MoF banks at the central bank, not sure how the Treasury uses the TGA.
A bank that buys anything either sends reserves to the recipient’s bank (which adds reserves and a corresponding deposit) or adds a deposit if the recipient banks with that bank itself. The banking system in aggregate adds a deposit, and reserves are unchanged. The exception is where it is dealing with the gov’t, as transfers there create or destroy reserves in the banking system.
So you agree that when a bank buys a UST at first a deposit is created and M2 goes up.
Next, Treasury can decide to transfer that deposit to its TGA - a reserve and deposit are withdrawn from the banking system, M2 goes down - and then Treasury can spend from its TGA - a reserve and deposit enter the banking system, increasing M2.
Sorry, maybe we talk different languages but I like to get a few facts straight.
As I noted, not if the banking system is dealing with the Fed, which is what happens with QT. The bank dealing with the Fed sends reserves, destroying them. The Fed does not leave money on deposit at private banks. What happens with the TGA is a separate issue.
Banks only create/destroy deposits when dealing with the private sector. The non-bank entity exchanges deposits vs. bonds on its balance sheet, the banking sector does the balancing transactions.
But the Fed doesn’t sell assets with QT? They just let them mature (run off balance sheet).
But I get your point: if a bank buys UST from the Fed it simply swaps a reserve for a bond.
My assumption was that there was some sales, which could easily be wrong. The mechanism seems to be more the repo facilities, which drain reserves.
As far as I can tell it doesn't really matter if the Fed sells its UST or just lets them mature, since the DoT issues and sells new USTs to replace maturing ones.
It matters in making a loss on them or not (for the Fed).