Paying interest on excess reserve balances

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It's not CB credit & the money stock that's impacted, rather it is money flows (MVt). Vt had 2.5 times the impact as M over a comparable 50 year period. The IOeR policy induces dis-intermediation (where the size of the non-banks (NBs) shrink, but the size of the CB system remains the same) -- all because the remuneration rate is higher than money market rates 2 years out (just like raising Reg Q ceilings [for just the CBs] caused the 1966 S&L housing crisis: from January 1966-July 1966 time deposits in CBs increased by 10.1 billion, compared with an increase of less than .5 billion dollars in the savings accounts of S&Ls).

The introduction of the payment of interest on excess reserve balances destroyed the shadow banks (a subset of the NBs). The NBs are the most important lending sector in our economy -- or pre-Great Recession, 82% of the lending market (Z.1 release, sectors, e.g., MMMFs, GSEs, etc.).

Lending by the NBs matches savings with investment. Lending by the NBs is non-inflationary (ceteris paribus). Lending by the NBs affects only the velocity. I.e.,savings are never transferred from the CBs to the NBs; rather are savings always transferred through the NBs. The funds do not leave the banking system.

The IOeR policy fosters an easier FOMC money policy & eventually stagflation. Real-gDp is up only 2.5% in 16 quarters ($13,326 in 4th qtr 2007 vs. $13,656 in 4th qtr 2012). And it took 4 years to get back to “break even”.  But the PCE is up 5.5% in 16 quarters ($110.275t in 9/2008 vs. $116.342t in 1/2013). Reflation has accelerated faster than real-output (giving us stagflation). It's all because economists don't know the difference between money & liquid assets (Gurley-Shaw thesis).

 

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Un-employment can't be permanently reduced by simply pumping up aggregate demand. If there is an inflation-unemployment trade off curve, it is shifting to the right at an accelerated rate. But unless money flows expand at least at the rate prices are being pushed up, output couldn't be sold, & then the work force would have to be cut back.

To assume that the Federal Reserve can solve our unemployment problem is to assume the problem is so simple that its solution requires only that the manager of the Open Market Account buy a sufficient quantity of U.S. obligations for the accounts of the 12 Federal Reserve Banks. That is utter naiveté.

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From the standpoint of the individual commercial banker, his institution is an intermediary. An inflow of deposits increases his bank’s clearing balances, & probably its legal reserves (gratis – not a tax), & thereby it’s lending capacity. But all such inflows involve a decrease in the lending capacity of other CBs (e.g., an outflow of cash & due from bank items), unless the inflow results from a return flow of currency held by the non-bank public, or is a consequence of an expansion of Reserve Bank credit. Note: the trend of the nonbank public's holdings of currency has been up since the 1920's, i.e., return flows are purely seasonal.

Thus IBDDs are indeed "lent" from the standpoint of an individual bank (have reserve velocity) but are not destroyed from a system's perspective (unless Federal Reserve Bank credit on the BOG’s balance sheet changes).

I.e., CBs need clearing balances to lend (from an individual bank’s perspective), but these “reserves” are either re-deposited within the same institution, or shifted to (clear thru) other CBs (reflecting the distribution of reserves from the system’s perspective). I.e., they are either derivative or primary inter-bank demand deposits (IBDDs) to member banks, but just a change in the composition of IBDDs for the system.

Even with CB credit expansion, total reserves remain the same, but their form may change if excess, or “precautionary” (liquidity) reserves need to be converted to legally “required” reserves (though since c. 1995, for our FRB system, reserves are no longer binding).

Note: c. 1995 legal (fractional) reserves ceased to be binding because increasing levels of vault cash (larger ATM networks), retail deposit sweep programs, fewer applicable deposit classifications, & lower reserve ratios, combined to remove most reserve, & reserve ratio, restrictions.

So excess reserves may be depleted (if not offset by the “trading desk”), as “factors that affect reserve balances change” (as currency is issued or as System Open Market Account securities are sold or “run off”, etc).

Fractional reserve (or prudential reserve) banking is a function of the clearing velocity of centralized bank deposits (based on interbank payments & settlements, i.e., liquidity backstops). Money creation is not a function of the volume of CB deposits. I.e., for the CB system, the whole is not the sum of its parts.

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1966 is the paradigm. The BOG & FDIC raised Reg. Q ceilings for the CBs on 5 successive occasion - until the NBs could not compete (& the NBs were already deregulated). Depression era policy kept the NBs holding loan inventories (earning assets), containing historically lower, & longer term, interest rate structures (the borrow short to lend long model).

Thus, due to differences in the character of the CB’s portfolios vs. the NBs portfolios (where maturity mis-matches involving 30 year fixed rate mortgages prevailed), the NBs suffered dis-intermediation (where the size of the NBs shrank, but the size of the CB system remained the same.

I.e., dis-intermediation for the CBs is not predicated on interest rate ceilings. The last period of dis-intermedation for the CBs occurred during the Great-Depression. Unlike the pre-1933 banking system, the CBs are backstopped today.

Excess reserves are remunerated @.25%. The remuneration rate inverts the short-end segment of the yield curve known as the money market. It is higher than the "Daily Treasury Yield Curve Rates" almost 2 years out.

It was legal (or required reserves) that were supposed to be an unfair tax [sic] on the bankers, not their unused excess reserve balances. Excess reserves are now the FOMC’s credit control device (the banks are being paid not to lend).

But it has been demonstrated over & over that it is impossible to control the money stock via interest rates ("finding tight short-term linkages between short-term interest rates and money growth is not empirically feasible" V.P. Fed's technical staff). I.e., Keynes's liquidity preference curve (demand for money) is a false doctrine. That’s what the Treasury-Federal Reserve Accord of 1951 was all about. That's how Bernanke single handedly caused the Great-Recession (regulatory malfeasance notwitthstanding)

It is also a major policy error. The payment of interest on interbank demand deposits (IBDDs) induces dis-intermediation (an economist's word for going broke). It is not that the shadow banks (SBs) are deleveraging (borrowers can't service their debt from the income streams received). Net worth didn’t decline because the provision for bad debt was growing. Net worth declined because the non-banks (NBs) couldn’t meet the current test of liquidity. The NBs must balance their assets & liabilities between liquidity & income.

Since the introduction of the payment of interest on excess reserve balances, there has been an outflow of loan-funds (short-term wholesale funding) from the NBs (creating negative cash flows), which shrinks the size of the NBs & forces the Fed to counteract its deflationary effect - by following an easier money policy (expanding CB credit). SB liabilities include: brokered CDs, asset-backed commercial paper (ABCP), interbank repurchase agreements, etc.

If the NBs can’t rollover, renew, or refinance their existing wholesale funding (contingent liability exposures), NBs must then sell off their earning assets. But even if the NBs find new financing this resets, or restructures, the NB’s cost of capital (payment periods, risks, & rates-of-return).

I.e., given the business model (where long-term loans are funded through short-term deposits & other liabilities (e.g., derivatives: swap, option, & securitization), the banks must match their aggregated liabilities (by duration buckets) with the corresponding earning assets to achieve positive cash flows (prevent gaps between the inflows & outflows of contractual collateral & cash), in order to maintain liquidity & solvency.

The IOeR policy will inevitably produce higher levels of stagflation (where more & more financing is accomplished by the creation of new money financed by the commercial & the reserve banks).

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No one bothered to learn the basics. CBs pay for what they already own. But the IOeR policy allows the CBs to out bid the NBs for short-term funding. And the NBs aren't in competitition with the CBs.

Savers (contrary to the premise underlying the DIDMCA in which CBs were assumed to be intermediaries) never transfer their savings out of the banking system (unless they are hoarding currency). This applies to all investments made directly or indirectly through the NBs.

Shifts from TDs to TRs within the CBs & the transfer of the ownership of these deposits to the NBs involves a shift in the form of bank liabilities (from TD to TR) & a shift in the ownership of (existing) TRs (from savers to NBs, et al). The utilization of these TRs by the NBs has no effect on the volume of TRs held by the CBs, or the volume of their earnings assets. I.e., the NBs are customers of the CBs.

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Lending by the CBs is inflationary (it expands both the volume & effects the turnover of new money). Lending by the NBs is non-inflationary (where lending is accomplished via the turnover of existing savings). This depends on other things being equal: i.e., the mis-allocation & mal-distribution of available credit notwithstanding.

Stagflation began as the CBs started buying their liquidity instead of storing it (e.g., 5 successive rises in Reg Q ceilings beginning 1957 ending 1965). This is when only the CBs had interest rate ceilings. I.e., the percentage of lending by the CBs increased relative to the NBs & real-output fell as inflation rose as a result.

In the decade ending 1964 money grew @ 2% roc (MVt @ 6%). In the next 10 years money grew @ 6.5% roc (MVt @ 13%). Note that the operations at the FRBNY's "trading desk" switched from regulating the net free or borrowed reserve position of the CB system, to pegging interest rates within the interbank market in c. 1965. This is how the Fed politically accommodated the CBs desire to get a bigger piece of the loan-pie (i.e., economists didn't understand the differences between money & liquid assets -the Gurley-Shaw thesis).

The same paradigm exists in an exaggerated form today. NB liabilites (reconstituted as Shadow Bank), accelerated after 1995 relative to CB liabilities. The ratio between them peaked in 2007 & has since been in a free fall. The Fed has counteracted this free fall by following an easier money policy. As NB liabilities fell by $6.2t the Fed accelerated its open market operations of the buying type - partially offsettting the decline (still there's been a net decline of $3.7t). But the policy mix gives us once again - stagflation (business stagnation accompanied by inflation).

Real-gDp is up only 2.5% in 16 quarters ($13,326 in 4th qtr 2007 vs. $13,656 in 4th qtr 2012). And it took 4 years to get back to “break even”.

But the PCE is up 5.5% in 16 quarters ($110.275t in 9/2008 vs. $116.342t in 1/2013).

Reflation has accelerated faster than real-output (giving us stagflation). Equities prices have demarcated this mix.

But the mindlessness of it is revealed when digging into the stats. I.e., Alton Gilbert's "Requiem for Regulation Q: What It. Did and Why It Passed Away is prima facie evidence. Gilbert's errors are symbolic.

The fact is savings were transferred to NBs in the last half of 1966 by lowering Reg Q ceilings for just the commercial banks. I.e., the CBs never suffer disintermediation (because they're backstopped). I.e., savings never leave the CB system in the first place. The CBs pay for what they already own.

After Reg Q ceilings were lowered for the CBs, they collectively became more profitable as a result. I.e., size is not synonymous with profitiability (net interest margins). And a larger percentage of savings were matched with investment.

The solution is to lower the remuneration rate & raise reserve requirements. Contrary to Friedmanites, reserve requirements are not a tax.

Reserve Bank credit (unlike CB credit), has been impounded (like the voluntary savings of the CB system). I.e., the CBs don't loan out interbank deposits, nor their existing customer's deposits (saved or otherwise). Nor do they loan out the owner’s equity, nor any liability item.

Prima facie evidence that the Reserve Banks & the commercial banks have created credit, as with all bank credit creation, is an expansion in the money stock. Prima facie evidence that the money stock (transaction based accounts) has expanded, is given by the rate-of-change in legal (required) reserves (the base).

So long as the 24 month roc in RRs (proxy for inflation) is no more than 2-3 percentage points above the 10 month roc in RRs (proxy for real-output), inflation is otherwise quiescent (i.e., for the last 100 years anyway).

"money flowing into savings deposits efficiently moves into the financial system to be used by banks and others for "riskier" investment activities"

As Hamlet said "There is something in this more than natural":

[Aman A.K.A. Ahamburger]

With the housing market really starting to come back after the crisis we just went through, keeping some liquid on the banks books isn't looking like such a bad idea eh? 

  Thought you might like this.  Seems to me Mr. B. was a little bit more on the ball then some want to believe... Bernanke Warned of Risks From Flawed Credit Ratings

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How ironic that Bernanke devalued housing prices creating mark-to-market losses?

"S&P issued credit ratings on more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion of CDOs from September 2004 through October 2007, according to the Justice Department complaint"

Bankrupt you Bernanke didn't ease policy. Lowering interest rates is not prima facie evidence of monetary easing.

The money supply can never be managed by any attempt to control the cost of credit (in the case of the Great-Recession - the FFR).

Prima facie evidence that the Reserve banks & the commercial banks have created credit, as with all bank credit creation, is an expansion in the money stock. Prima facie evidence that the money stock (transaction based accounts) has expanded, is given by the rate-of-change in legal (required) reserves (the base).

I.e., even as the federal funds rate was lowered, the money stock (& RRs) didn't keep pace. Bankrupt you Bernanke actually drained legal reserves for 29 consecutive months. Bankrupt you Bernanke then drained reserves again in the 4th qtr of 2008 (as the economy fell into a recession/depression).

So long as the 24 month roc in RRs (proxy for inflation) is no more than 2-3 percentage points above the 10 month roc in RRs (proxy for real-output), inflation is otherwise quiescent (i.e., for the last 100 years anyway).

It should be quite obvious to any student of monetary policy that the FRB-NY's "trading desk" can't hit any target (stimulate the economy), by just purchasing $40 billion of mortgage-backed securities & $45 billion of Treasury securities each month.

The FOMC's technical staff has no formula which supports this input pace. Has bankrupt you Bernanke learned this? "we may adjust the flow rate of purchases from month to month to appropriately calibrate the amount of accommodation".

So where does that leave us? In an economic sea without a rudder or an anchor.