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Does the Federal Reserve Obtain Competitive and Appropriate Prices in Monetary Policy Implementations?

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Document pages: 57 pages

Abstract: The Federal Reserve s (Fed) monetary policy implementations often involve extremely large trades within a short time frame and exclusively transact with primary dealers at pre-committed time and quantities. We show that dealers exert market power against the Fed, which is remarkably stronger than that against regular customers. In the agency MBS market, we find that (1) dealers accumulate MBS inventory before Fed purchases and several large dealers acquire most inventory; (2) the same dealer charges discriminatorily higher prices to the Fed than to non-Fed buyers when selling from the same inventory; (3) the Fed s large purchase amount relative to dealers inventory capacity and operational inflexibility account for half of the uncompetitive pricing each; (4) large dealers extract higher rents and sell more quantities to the Fed than small dealers do.

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