Remunerating Excess Reserves (IBDDs)

[flow5]

"The interest on reserves regime is an attractive extension of 30 years of financial and monetary innovation. It gives us interest-paying money, the end of monetary frictions, and the foundation of a more stable financial system in which government short-term debt drives out private short term debt, much as government notes drove out banknotes in the 19th century"   --  John Cochran

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Wrong.  This is the economic law that applies to paying interest on interbank demand deposits held at the District Reserve banks (which are owned by the member commercial banks):

Gresham’s law is a statement of the “principle of substitution” as applied to money: a commodity (or service) will be devoted to those uses which are most profitable. It is another one of the paradoxes of money that, unlike articles in the market, the bad drives out the good.

[flow5]

Blasphemy: Fed Chair Yellen described the same plan on May 7, 2014 in response to a question during testimony before the Joint Economic Committee of Congress. Besides raising interest rates paid to banks on excess reserves, "she pointed to the 'reverse repo' facility the central bank has been experimenting with since September."

"Raising the interest paid on excess reserves to even three percent, for example, may be necessary to keep the bomb from rapidly exploding if market rates rise and banks begin rapidly investing the $2.58 trillion excess reserves in the non-bank private sector."

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This is an academic.  Does anyone understand what's wrong with this statement?  

In the General Theory, John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution serving to join the saver with the borrower when he states that it is an “optical illusion” to assume that “a depositor & his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”

In almost every instance in which Keynes wrote the term bank in the "General Theory", it is necessary to substitute the term financial intermediary in order to make Keynes’s statement correct. This is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, the elimination of Reg Q ceilings, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, the Financial Services Regulatory Relief Act of 2006, the Emergency Economic Stabilization Act of 2008, sec. 128. “acceleration of the effective date for payment of interest on reserves”, etc.

Thus we are destined to learn the hard way, viz., there really is a difference between money and liquid assets.

[flow5]

"The Federal Reserve policy of paying banks to hold $2.7 trillion of excess reserves they are not required to hold is an incentive for banks to reduce loans to business, consumers and other income earning assets," Auerbach writes. "This Fed's policy that began in October 2008 reduces employment and the production of goods and services for the people of the United States."

Auerbach recommends that the Fed sell its longer-term Treasury bonds to the public while reducing interest it pays on excess reserves.


"One thing I worry about is that if we are late, in this environment, with all these excess reserves, the consequences might be . . . more dramatic than in previous times," Plosser said. "If you study the Fed over the years, over its history, it's always behind the curve."

 

[flow5]

William T. Gavin, an economist at the St. Louis Federal Reserve, wrote in its March/April 2009 Fed publication: "first, for the individual bank, the risk-free rate of ¼ percent must be the bank's perception of its best investment opportunity."

Credit worthy borrowers aren't the issue.   In effect, the remuneration rate has become both (1) the Regulation Q ceiling rate (the dis-intermediation rate for the non-banks), and (2) the target FFR.

[flow5]

Yeah, I'm infected (the only one in the world that got both the bottom in bonds (my prediction for AAA corporate yields for 1981 was 15.48% - off by 1 basis point) and the top in bonds (July 2012) in the 31 year bull market in bonds.

[damnotagain]

Banks being paid a higher rate NOT to lend money. 4.5 trillion in new debt 80 billion maybe made it to Main Street. Markets never looked better. 

Nice call on the AAA bonds. 

Great reading.

[flow5]

"The McCallum rule is a monetarist rule that emphasizes the growth rate of money. It states that the Federal Reserve should target a monetary base growth rate equal to the target inflation rate plus the ten-year moving average of the real GDP growth rate minus the four-year moving average of the monetary base velocity."

"In monetary policy, the McCallum rule specifies a target for the monetary base (M0) which could be used by a central bank." Wikipedia

Forbes: "In any case, there can be no doubt that IOR itself is deflationary. Everyone, including Professor Cochrane, agrees that IOR neutralizes the inflationary power of excess reserves. Ipso facto, this means that IOR is deflationary."

"Now, it is true that the FDIC assesses deposit insurance premiums of 20 bp on all bank assets, so the banks are making only 5 bp of margin on today’s 25 bp IOR rate."

Maybe I should name my forecasting rule - The GOSPEL

[Aman A.K.A. Ahamburger]

The other way to look at it is that IOR has staved off hyperinflation indefinitely, and allows money to flow into the economy in the future at a stable pace(like when the global conflict explodes China goes down the tubes with Europe). The reason for the lack of work is because of offshoring - a trend that is reversing - and the fact the USA was heavily reliant on the construction industry, not unlike China is right now. That, and the fact that financial wizardry turned the US banking industry in a "zombie" industry - again not unlike China is now.

I'm pretty sure the man who said that the bull market in bonds continues - as it is - called the 15th of October months in advance. As he says, just a thought.

[flow5]

Tripe. As rates are higher now the 31 year bull market in bonds is already over.  You have no idea what was significant about Oct 15th either.

Ahamburger says: “allows money to flow into the economy in the future at a stable pace”

Explain just how this works if you actually know what you’re talking about.  Otherwise, stop the blatant harassment.

And the theoretical grounds for his model are dead wrong - Post hoc ergo propter hoc

[Aman A.K.A. Ahamburger]

But yields are way down from the start of the year, so for the trader/market timer the bull market in bonds continues.

I never claimed to know what was significant about the 15th, just that the best market timer I know was calling it months in advance, before anyone. In fact, I couldn't care less because everyone knows that market goes up and down. The whole idea is to buy stocks when the chips are down - it's just that few do.

Oct 21, 2014 18:55:37 GMT -5 flow5 said:

Ipso facto, this means that IOR is deflationary.

Let's see.. People complaining about rising food costs - caused by a run up in commodity prices. Housing prices up, consumer prices rising, wages rising but not keeping place with inflation.. Ya, the US economy is in a deflation situation alright..

Now the EU is another story, but since that is an issue with an even worse banking system than the US... China is about to enter a depression because of socioeconomic, environmental, and real estate issues - so that's another deflation situation... The Middle east conflict is on the verge of engulfing the eastern hemisphere, that's a deflation situation.. Now, what ever will the US do in the face of these global deflation issues?? Oh ya! Open the gates of all this money in reserve and keep the US economy from entering the same downward spiral! A.K.A the pundits that have been crying hyper inflation from money printing are going to eat crow.

I'm not trying to bother you, flow. But since you think you have the gospel and anyone who doesn't agree with you is a false profit, I'll just go back to ignoring you - no biggie.

[flow5]

You can have the whole blog (MSN money) to yourself. Good bye