Forthcoming
Article
Journal of Finance

The Imperfect Intermediation of Money-Like Assets

By: Jeremy C. Stein and Jonathan Wallen

Format:Print

Abstract

We study supply-and-demand effects in the U.S. Treasury bill market by comparing the returns on T-bills to the administered policy rate on the Federal Reserve’s reverse repurchase (RRP) facility. In spite of the arguably more money-like properties of an investment in RRP, we observe repeated episodes where one-month T-bill rates fall well below expected RRP rates. This gap frequently exceeds 50 basis points in 2022, before spiking to over 160 basis points during the initial period of uncertainty over the debt ceiling in March and April of 2023. In an effort to understand this phenomenon, we develop and test a simple model where the RRP-bill spread is policed by a group of heterogeneous money funds, who differ in their elasticity of substitution between the two assets. Our main finding is that when T-bills are scarce, and the spread is large, the marginal money fund is more inelastic, as the more elastic funds have already exhausted their holdings of T-bills. As a result, for a given shift in T-bill supply, the effect on rates is an order of magnitude larger when T-bills are scarce, and when more money funds are out of the market.