Money Market

The money market is the market for short-term financial instruments, typically with maturities of one year or less. The money market is the market in which banks, firms, and governments manage their short-term liquidity and in which the central bank conducts monetary policy.

Instruments

The instruments of the money market include treasury bills, commercial paper, certificates of deposit, and repurchase agreements. These instruments are characterised by short maturities, high liquidity, and low credit risk.

Treasury bills are short-term securities issued by governments, and they are the lowest-risk instruments in the market. Commercial paper is short-term debt issued by firms, and it is used to finance working capital. Certificates of deposit are short-term deposits issued by banks, and they are traded in the market. Repurchase agreements are short-term collateralised loans, in which one party sells a security and agrees to buy it back at a higher price.

Participants

The participants in the money market include banks, which are the central institutions, and other financial institutions, including money market funds, insurance companies, and pension funds. Non-financial firms also participate, to manage their cash balances.

The central bank participates in the money market when it conducts open market operations, buying and selling securities to influence the liquidity of the banking system and the level of short-term interest rates. The operations are the primary means by which the central bank implements monetary policy.

Functions

The money market performs several functions. It provides a mechanism for the management of short-term liquidity, allowing institutions to invest surplus funds and to obtain funds when needed.

The market also provides a mechanism for the pricing of short-term credit, and the interest rates established in the market are the reference rates for many other transactions. The rates are used to price loans, to index contracts, and to value derivatives.

The market is also the channel through which monetary policy is transmitted, since the central bank operates in the market to influence the short-term rates that are the starting point of the transmission mechanism.

Stability

The stability of the money market is essential to the functioning of the financial system. The market is the source of short-term funding for banks and other institutions, and a disruption can rapidly affect the availability of credit.

The crisis of 2007 and 2008 saw a severe disruption of the money market, as institutions lost confidence in one another and the market for some instruments, including asset-backed commercial paper, ceased to function. The disruption prompted extensive intervention by central banks, including the provision of liquidity and the guarantee of some instruments.

The experience led to reforms, including the regulation of money market funds and the strengthening of the infrastructure of the market. The reforms are intended to reduce the risk of runs and to improve the resilience of the market.

Repurchase Agreements

Repurchase agreements, or repos, are short-term collateralised loans, in which one party sells a security and agrees to buy it back at a slightly higher price. The difference between the sale and the repurchase price is the interest on the loan.

Repos are a central instrument of the money market, used by banks and other institutions to manage their liquidity. They are also used by central banks in their open market operations, where they provide liquidity to the banking system against collateral.

The market for repos was at the centre of the financial crisis, when concerns about the quality of the collateral led to a disruption of the market. The disruption prompted reforms, including the introduction of central clearing for some repos and the strengthening of the infrastructure of the market.

Commercial Paper

Commercial paper is short-term debt issued by firms to finance their working capital. It is typically issued at a discount and has a maturity of up to 270 days.

The market for commercial paper is an important source of short-term funding for large firms, and it is an alternative to bank borrowing. The market is used by financial and non-financial firms, and it is a key element of the short-term funding markets.

The market was disrupted during the financial crisis, when the failure of a large fund led to a loss of confidence in the asset-backed commercial paper market. The disruption prompted the intervention of the central bank, which provided support to the market.

Money Market Funds

Money market funds are investment funds that invest in short-term instruments and seek to maintain a stable net asset value. The funds are used by investors as an alternative to bank deposits.

The funds are subject to the risk of runs, since investors may withdraw their funds if they perceive a risk to the value of the assets. The risk was realised during the financial crisis, when a large fund experienced losses and the value of its shares fell below the fixed level.

The experience prompted reforms, including requirements for the funds to hold liquid assets and to disclose the value of their assets, and the introduction of mechanisms to manage the risk of runs.

Summary

The money market is the market for short-term instruments and is central to the management of liquidity and to the conduct of monetary policy. The instruments of the market, including repos and commercial paper, and the institutions that participate in it, are central to the functioning of the financial system.

References

^[1] ^[2] ^[3]

↑ Research on the money market and on its instruments.
↑ Studies of the disruption of the market during the crisis.
↑ Analyses of the reform of the money market and of its infrastructure.

[r1-1] Research on the money market and on its instruments.

[r2-2] Studies of the disruption of the market during the crisis.

[r3-3] Analyses of the reform of the money market and of its infrastructure.

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