Monetary Policy Implementation and Financial Vulnerability : Evidence from the Overnight Reverse Repurchase Facility

In this paper, we demonstrate how monetary policy implementation that relies on intervention in financial markets can significantly affect those markets, with potential implications for financial stability. Specifically, we examine the experience with the Federal Reserve's newest policy tool, known as the overnight reverse repo (ONRRP) facility, to understand its effects on the repo market. Using exogenous variation in the parameters of the ONRRP facility, we show that private repo activity is crowded out when money fund repo lenders invest in the ONRRP. Additionally, using a confidential data set of repo transactions, we find that the presence of the Fed as a borrower in the repo market increases the bargaining power of cash lenders, leading to increased funding costs for borrowers. Lastly, we show that repo borrowers do not decrease their total repo borrowing in response to this adverse funding shock, but instead increase borrowing against riskier collateral types from non-money fund lenders, while also boosting lending from more asset-volatile money funds ineligible for the ONRRP. Both of these reactions could lead to heightened financial fragility resulting from instability in private repo funding