Jan. 7 (Bloomberg) -- Federal Reserve Bank of San Francisco President John Williams said reverse repurchase transactions may be an effective way for the Fed to control interest rates when it starts withdrawing unprecedented stimulus.
“This is potentially a very useful tool,” Williams said to reporters today after a speech in Phoenix. “It allows us to manage short-term interest rates more directly even at the same time that we have a very large balance sheet and lots of excess reserves.”
Federal Reserve Bank of New York President William C. Dudley said last week the Fed may decide to extend the reverse repo program, aimed at putting a floor under short-term money market rates. The mechanism allows banks, broker-dealers, money-market funds and some government-sponsored enterprises to lend the Fed unlimited amounts of cash overnight at a fixed rate in exchange for borrowing Treasuries in reverse repo transactions.
“We could decide at some future date to make it operational,” Dudley said in Philadelphia on Jan. 4.
The Federal Open Market Committee “will be talking about and evaluating” lessons from tests of the reverse repurchase transactions while considering ways to manage interest rates, said Williams, who doesn’t hold a policy vote this year.
“I was already confident in our ability to control interest rates,” Williams said. “This is just a really nice tool to really implement that maybe a little more cleanly.”
Policy makers, aiming to fuel the recovery and combat unemployment, have held the main interest rate at a record low of zero to 0.25 percent for more than five years.
The Fed has also purchased bonds in an effort to reduce long-term interest rates, pumping up the Fed’s balance sheet to $4.02 trillion. Last month, central bank officials decided to taper monthly bond buying to $75 billion from $85 billion, citing improvement in the labor market.
Williams said that he doesn’t believe the U.S. stock market is overvalued even after the Standard & Poor’s 500 Index jumped 30 percent last year, the most since 1997.
Expectations are already “built in” to the market that the Fed will slow and stop bond buying and later raise interest rates, he said.
“It doesn’t seem to me that the level of the stock market today is all that much out of alignment with fundamentals,” Williams said. “The growth in the stock market was basically making up for the big declines and weakness that we’d seen earlier, so I don’t see the stock market as being overvalued in some fundamental broad way.”
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