The US money market turmoil in the second half of 2019 has taught us that excess liquidity (or its synonym, excess reserves) is a misleading term. In the late summer/early autumn the Fed lost control over short term rates when excess reserves fell just below $1.3 trillion. In other words, even though the banking system appeared to be awash in reserves, repo rates spiked, which in turn resulted in an increase in the federal funds rate that was roughly consistent with a quarter percent increase in the target federal funds rate. To regain control of money market rates, the Fed was forced to inject more than $400 billion of reserves into banking system through a combination of Treasury bill purchases and ad hoc repo lending. In the Eurozone the introduction of the ECB’s tiering system on November 1 effectively sterilized roughly 700 billion euros in excess reserves. Sterilized because banks will only lend out these excess reserves in the interbank market when the borrower is willing to pay an interest rate that is several basis points above zero. Given the prevalence of still (deeply) negative interest rates in the Eurozone money market, reserves that the ECB remunerates at zero are effectively removed from the market – sterilized in jargon.

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