Flexibility is a critical element of the Federal Reserve’s approach to policy normalization. Policymakers have said that they will adjust the IOER rate and parameters of an ON RRP facility, and use other supplementary tools as necessary – including term tools – during the normalization process. In doing so, they will weigh the efficacy and costs of each of the tools in their arsenal to ensure that they are optimizing policy objectives while maintaining appropriate interest rate control. I’ll now explain our confidence in and readiness to implement this approach. 10  That said, to the extent that an ON RRP facility’s existence provides a credible outside investment option to money market lenders, it could potentially improve competition and support interest rate control even without large actual use of the facility. 11  These assumptions are derived from responses to the Desk’s Survey of Primary Dealers (December 2014), in which respondents expected liftoff to occur in the second quarter of 2015 and principal reinvestments of SOMA securities holdings to end two quarters later, and include a neutral assumption that the FOMC returns to a long-run operating framework with a relatively low level of excess reserves. Survey results are available at http://www.newyorkfed.org/markets/survey/2014/December_result.pdf. For more details on this projection scenario, please see the Report on Open Market Operations during 2014 (Federal Reserve Bank of New York, April 2015), available at http://www.newyorkfed.org/markets/annual_reports.html.

As a result, the size of the fed funds market has declined relative to pre-crisis levels and the nature of most fed funds activity has changed. Nevertheless, trading volumes remain reasonably robust. Since July 2014, the average overnight borrowing in the fed funds market that banks report to the Fed through our FR 2420 reporting form has been roughly $ billion, with an average of about 300 transactions per day (Figure 7). 22 Moreover, longerterm correlations between fed funds and other money market rates remain robust, with the fed funds rate remaining a suitable measure of banks’ marginal borrowing costs. A variety of regulatory changes and other developments have also influenced motivations for participating in fed funds and other money markets. Liquidity and capital rules affect the management of bank balance sheets and the costs of many money market transactions, affecting banks’ incentives to engage in short-term borrowing, arbitrage between different money market rates, and provide customers access to their balance sheets. Notably, regulatory changes affect different institutions in different ways. For example, changes to the calculation of FDIC deposit insurance assessment fees affect primarily domestic banks. The implementation of Basel III banking standards also varies by jurisdiction, so the rules for foreign bank branches operating in the United States are somewhat different than those for domestic institutions. 23 The effects of regulatory requirements on money market dynamics can be seen especially around key financial reporting dates. As many market commentators have noted, some borrowers actively manage their balance sheets on quarter-end dates.