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Treasury market bleg

Summary:
Here’s Bloomberg: The Treasury market is now so large that the U.S. central bank may have to continue to be involved to keep it functioning properly, according to Federal Reserve Vice Chair for Supervision Randal Quarles . . .“It may be that there is a simple macro fact that the Treasury market being so much larger than it was even a few years ago, much larger than it was a decade ago and now really much larger than it was even a few years ago, that the sheer volume there may have outpaced the ability of the private market infrastructure to support stress of any sort there,” Quarles said. In plain English, what does this mean? What is the bad thing that would happen in the Treasury market if the Fed did not intervene in times of stress? If that bad thing happened,

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Here’s Bloomberg:

The Treasury market is now so large that the U.S. central bank may have to continue to be involved to keep it functioning properly, according to Federal Reserve Vice Chair for Supervision Randal Quarles. .

“It may be that there is a simple macro fact that the Treasury market being so much larger than it was even a few years ago, much larger than it was a decade ago and now really much larger than it was even a few years ago, that the sheer volume there may have outpaced the ability of the private market infrastructure to support stress of any sort there,” Quarles said.

In plain English, what does this mean? What is the bad thing that would happen in the Treasury market if the Fed did not intervene in times of stress? If that bad thing happened, would it create an easy profit opportunity for someone like me (an investor who can wait out periods of stress?)

Why does increased size make the Treasury market more fragile? One normally thinks in terms of size and liquidity being positively correlated. Is “stress” different from illiquidity?

Suppose the Fed intervened in the MBS market during times of stress in the T-bond market. Would that fail to address the problem? I.e., is the problem Treasury debt-specific, and not just a generalized lack of liquidity, (which can be addressed by adding more reserves?)

How does this problem relate to the “safe asset shortage” that people often discuss? Would addressing the safe asset shortage by issuing more T-bonds also make the Treasury market bigger and thus even more fragile?

PS. Just to be clear, Quarles does not seem to be discussing central bank support of government debt in the traditional sense, which meant intervening to keep government financing costs low. When the Fed injects more reserves into the system, they tend to pay interest on those reserves at a rate comparable to T-bill yields. Thus the Fed is not “monetizing the debt” in the original meaning of the phrase.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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