When used in conjunction with the Fed's power

Mr. Potter said that market participants have told the Fed that the overnight reverse repos "should be an effective tool for increasing the Federal Reserve's control of short-term money market rates through a stronger floor." He added, "money market experts have noted the exercise's importance in the current environment of promoting market functioning; for example, it reduces the likelihood of pervasive, negative short-term rates trading."Mr. Potter said that the reverse repo facility is particularly helpful because it reaches a wide range of market participants, and he said that it doesn't even have to be used heavily to help the Fed gain greater control over short-term rates in some future tightening cycle. But he added that the reverse repos are unlikely to be a silver bullet on their own.

When used in conjunction with the Fed's power to pay interest on reserves–that helps keep cash on the Fed's books and out of the economy–Mr. Potter explained the reverse repos "may strengthen the floor for short-term interest rates and, with it, the Federal Reserve's control of money market rates, by surmounting the competitive and balance sheet frictions seen in money markets and by extending the central bank's payment of interest to a wider universe of relevant counterparties."Simon Potter, the Federal Reserve Bank of New York's markets group chief, said the Fed's new reverse repurchase agreement tool probably will be a key part of how the central bank eventually tightens monetary policy.

Market "participants have indicated that they expect that a facility, if executed in full scale in the future, should be an effective tool for increasing the Federal Reserve's control of short-term money market rates," Potter said yesterday in a speech in New York. He is in charge of the System Open Market Account used in implementing monetary policy.Fed officials have been testing the new tool -- known as a fixed-rate, full allotment overnight reverse repo facility -- aimed at improving their control of near-term borrowing costs when they tighten policy by siphoning off excess cash in the banking system."Operationally, market participants generally characterize the exercise as smooth, with minimal disruptions," Potter said.The program would allow banks, broker-dealers, money-market funds and some government-sponsored enterprises to lend the Fed unlimited amounts of cash overnight at a fixed rate, currently 0.05 percent, in exchange for borrowing Treasuries in so-called reverse repo transactions.