A coupon pass occurs when the Federal Reserve, which is the central bank of the United States, makes a permanent purchase of bonds or Treasury notes from dealers. When the Federal Reserve buys these bonds or Treasury notes though a coupon pass, the dealer’s bank reserves increase. The increase is usually directly proportional to the amount of money received by the bank from the Federal Reserve for the sold bonds or Treasury notes.
The Federal Reserve may elect to engage in coupon pass transactions when a high demand for money exists in the marketplace. If the United States is experiencing a recession, the Federal Reserve may choose to conduct coupon pass transactions in order to help stimulate the economy. Another key reason that the Federal Reserve makes these bond and Treasury note purchases is to provide the banking system with additional funds. If, for example, the Federal Reserve predicts that a permanent increase to the banking system’s liquidity is necessary, it may make a coupon pass purchase. Coupon passes can also be used by the Federal Reserve to help keep the federal funds rate at target levels.
Coupon passes are distinct from repurchase agreements. Coupon passes usually involve permanent sales of securities to the Federal Reserve. On the other hand, a repurchase agreement is a contract between the Federal Reserve and a dealer whereby the Federal Reserve agrees to temporarily buy the securities from the dealer. The dealer then agrees to repurchase the securities on a specified date. Generally, the securities are sold back to the dealer within just a few days of the Federal Reserve’s initial purchase.
The Federal Reserve may also seek to adjust banking reserves through a transaction called a bills pass. Similar to a coupon pass, a bills pass involves the Federal Reserve making an outright purchase in order to inject funds into the banking system. In a bills pass transaction, however, the Federal Reserve purchases Treasury bills from dealers rather than coupon pass Treasury notes or bonds.
Coupon passes, repurchase agreements and bills passes can all help relax monetary policies. When the Federal Reserve wishes to restrict monetary policies, it may engage in reverse purchase agreements or sell securities outright to dealers. In a reverse repurchase agreement transaction, the Federal Reserve sells securities with the intent of buying them back at a later period in time. This can decrease the amount of money in the banking system and reduce economic growth. These types of agreements and sales are less common than purchases by the Federal Reserve.