Counterparties: Reservations about reserves

By Ben Walsh
July 31, 2012

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Banks currently have $1.5 trillion in excess deposits at the Fed, earning 0.25% — a reasonably healthy amount, in a world where T-bills yield even less. So why would banks want to move money out of the Fed and lend it into the economy? It’s possible that even the latest rumblings of new Fed actions to boost the economy may not have much effect, because the real anchor holding down growth is sitting in the Fed’s own vault.

That’s the core of Bruce Bartlett‘s diagnosis. For Bartlett, with interest rates already so low, the remedy lies elsewhere:

The Fed can penalize banks for holding excess reserves by charging them interest rather than paying them interest. This has been done in other countries. From July 2009 to July 2010, the central bank of Sweden charged banks 0.25 percent on their reserves, and on July 5 the central bank of Denmark announced that it would begin charging an interest rate of 0.2 percent on reserves.

In effect, this reduces the real interest rate received by banks and thus, ironically, would ease monetary policy and encourage bank lending.

Bartlett is pushing banks to get excess capital out of the Fed and into the economy. If bankers are “traveling money salesman” and the Fed stops paying interest on their excess deposits, why not give them a new task: hit the road and start hawking loans to customers.

Mike Shedlock disagrees with Bartlett: penalties on excess reserves “sure would get banks to do something, but that something might not necessarily be lending! For example, banks might bet against the US dollar, bet on gold, plow into the stock market, etc.” For Peter Stella the argument boils down to a misguided beliefs that excess deposits and lack of credit are connected. Reducing excess deposits, he argues, would actually cause credit to contract. Michael Pento thinks Bartlett’s idea would lead to more lending, but the wrong kind. Banks would “[shove] loans out through the drive-up window with a lollipop… They will be forced to take a chance on loans to consumers, at the exact time when they should be getting rid of their existing debt”.

Allen Binder thinks the British are on the right track in tackling a lack of lending from a different angle: Instead of penalizing excess reserves, “the more a bank lends, the more it saves on funding costs [from the Bank of England]… no bank is forced to lend, nor told what loans to make”. – Ben Walsh

On to today’s links:

EU Mess
Greece is on the brink of bankruptcy, with “cash reserves [at] almost zero” according to finance minister – Reuters

New Normal
Just 54% of Americans 18-24 were employed last year, the lowest level since data has been kept – FT
Bill Gross: The “cult of equity is dying”. Lenders, labor and the government will get returns – Pimco

Plutocracy Now
There’s just no place like America to be a billionaire – Mother Jones

When Regulators Stop Being Polite
Geithner: Fannie and Freddie’s refusal to use targeted principal reductions is not “the best decision for the country” – Treasury Department
DeMarco: Principal reductions do not improve foreclosure avoidance or reduce taxpayer costs – Federal Housing Finance Agency
DeMarco has “a deep aversion to reducing principal” that is common among bankers and lenders, and he should step aside – Jared Bernstein

Alpha
Shares of companies with women on their boards outperform similar companies with all-male boards by 26% – Bloomberg

Oxpeckers
“We have no patience for mystery. We want the deciphering of gods. We want oracles … right now” – Ta-Nehisi Coates

Ouch
The “linchpin of [Romney's] economic strategy is to further enrich the richest 1%” – American Progress

5 comments

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We shouldn’t be relying on the Fed to manage the economy, as they just don’t have the right tools. It should be apparent to everyone by now that controlling the supply of money via interest rates is cannot be depended on to spur or slow down growth, and that other mechanisms are required.

Proponents of lower taxes claim that when taxes are low, people and businesses have more money to invest. However, the excess cash suggests there is plenty of capital to invest, what is lacking is the will to invest. That is a flaw in the “low taxes will spur investment” wish; instead of wishing or hoping or praying that people will invest, we need to structure the tax code so that those who are accumulating cash either spend it or invest it, and we can do that by taxing income (all forms) higher, and then providing credits for investment.

We have proven that low interest rates will not increase investment or consumption, so let’s stop debating what the Fed should do, and get Congress to institute policy that gets more profits back in circulation.

For all of the long time readers of comments here, sorry for the repetition, but hey, as long as people keep talking about using hammers on screws, I’ll keep suggesting they switch to screwdrivers.

Posted by KenG_CA | Report as abusive

“Just 54% of Americans 18-24 were employed last year, the lowest level since data has been kept”

Doesn’t this go hand-in-hand with increased college enrollment? Though paid employment opportunities are increasingly scarce for the young — entry level jobs are being replaced with “internships”.

Posted by TFF | Report as abusive

Do we really think a bank is going to pass up a profitable loan?

Let’s step back from the money multiplier “theory” for a second and think about how a business actually works, even a bank. Reserve positions only come into play at the end of the loan process (to cover the new deposit the bank just added into the receiver’s account), not the beginning.

Besides, even if the fed started taxing reserves, banks would just sweet them into the same asset by a different category, and magically, it’s not a reserve.

Posted by djiddish98 | Report as abusive

“Do we really think a bank is going to pass up a profitable loan?”

That is the wrong question – unfortunately, Walsh obscured the point by fixating on the bank lending angle. The question is, do we really think a bank is going to pass up a loss-making deposit? And the answer is, it will if it can.

In aggregate, banks are doomed to fail in this ambition because only the Fed can destroy base money. But that won’t stop each individual bank from doing its best to unload its unwanted reserves on another bank. Whatever measures it takes – say, charging interest on deposits – will transmit a reduced propensity to hold money throughout the economy. That translates to an increased propensity to spend.

The argument against this measure is that there might be unforeseen consequences, such as cash hoarding. The point of bringing up Sweden and Denmark, and the decades during which the Fed paid no interest on reserves, is that the available evidence suggests otherwise.

Posted by Greycap | Report as abusive

Banks DO NOT LEND RESERVES! Bank lending IS NOT RESERVE CONSTRAINED!Hoping to “force” banks to lend by penalizing them for holding exess reserves is the hight of stupidity. Anyone who considers such proposals knows nothing about banking. Bank lending is only constrained by: 1.Presence/lack of creditworthy borrowers 2. Capital reqiurements. That’s all that matters.

Posted by DLT | Report as abusive