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Notes and Papers

Liquidity Regulations, the Neutral Real Federal Funds Rate, and the Money Premium

By Bill Nelson

In this research note, TCH presents evidence that additional liquidity regulation, like the net stable funding ratio, puts downward pressure on neutral real federal funds rate, or r*, thereby reducing the ability of the Federal Reserve to provide stimulus to the economy and increase the frequency with which the Federal Reserve needs to resort to extraordinary monetary policy measures.  Moreover, tighter liquidity regulations make money-like instruments more valuable (i.e., raise the so called “money premium”).  The increase in the money premium provides incentives for private financial intermediaries to issue certain types of collateralized short-term debt that could lead to a re-expansion of the shadow banking sector that played a major role in the last financial crisis.