Repurchase agreements (RPs) are transactions in which the Fed buys securities from dealers with an agreement to resell the same securities to the original seller at the same price + interest, usually the next day. Thus, the operation is actually a lending of reserves by the Fed, secured by the securities bought and sold. Reverse repurchase agreements (RRPs) are the opposite transaction where the Fed sells securities with an agreement to buy them back at the original price + interest. In RRP therefore the Fed temporarily withdraws reserves from the banking system.
Yesterday (March 23) the Fed announced that it will conduct small amounts of RRPs as a test so “that this tool will be ready if the FOMC decides it should be used”. This sounds strange. First, the Fed has been conducting RRP’s, from time to time, for some decades. Second, and more importantly, the instruments of RPs and RRPs are designed to make small temporary adjustments to the amount of bank reserves. With excess reserves now at $1.3 trillion, when the Fed decides to tighten even slightly it will have to absorb over a $1 trillion of reserves permanently. And the Fed is still increasing the size of the problem through quantitative easing 2.
More on Quantitative Easing