This is due to its ability to
pay interest on bank reserves.
At TSI over the past year and at the TSI Blog two months ago I've made the point that the Fed gave itself the ability to
pay interest on bank reserves so that the Fed Funds Rate (FFR) could be raised without the need to shrink bank reserves and the economy - wide money supply.
Consequently, on the same day that it announced its plan to
pay interest on bank reserves, the Fed at last relented by cutting its rate target to 1.5 percent.
During the interim, the Federal Reserve indicates that it expects to limit the extent to which banks lend out the base money created in Step 1, through a policy of
paying interest on bank reserve balances.
Finally, since October 2008, the Fed has been
paying interest on bank reserves, at rates generally exceeding the yield on Treasury securities, thereby giving them reason to favor cash reserves over government securities for all their liquidity needs.
This is hardly surprising, given that the Fed began
paying interest on bank reserves in October 2008 — a move designed to encourage banks to build up excess reserves, instead of increasing lending.
Factors such as the Fed choosing to
pay interest on bank reserve deposits, the large cash holdings of big firms, and the persistent regime uncertainty that makes lending / investing seem particularly risky these days can together explain the reluctance of the banks to turn the monetary base into money via the multiplier process.
In practice, monetary policy conducted by
paying interest on bank reserves is untested.
Not exact matches
On - line banking lets them move cash between accounts to pay bills while they still earn as much interest as possible on their cash reserve
On - line
banking lets them move cash between accounts to
pay bills while they still earn as much
interest as possible
on their cash reserve
on their cash
reserves.
Because the stock of
reserves is so high, central
banks pay «
interest on reserves» (IOR) to influence market
interest rates.
It has done so by introducing three distinct
interest rates
on reserves: required
reserves — which
banks must hold — these are
paid zero, and are relatively small in quantity; existing
reserves — these are now
paid 10bps; and a new third tier — a «policy balance» which will be
paid minus 10bps.
By
paying interest on excess reserves (IOER), the Fed rewards banks for keeping balances beyond what they need to meet their legal requirements; and by making overnight reverse repurchase agreements (ON - RRP) with various GSEs and money - market funds, it gets those institutions to lend funds to i
on excess
reserves (IOER), the Fed rewards
banks for keeping balances beyond what they need to meet their legal requirements; and by making overnight reverse repurchase agreements (
ON - RRP) with various GSEs and money - market funds, it gets those institutions to lend funds to i
ON - RRP) with various GSEs and money - market funds, it gets those institutions to lend funds to it.
As part of these
bank -
reserve writings I addressed the reasoning behind the Fed's decision to start
paying interest on reserves, reaching the conclusion that the decision had been taken to enable the Fed Funds Rate (FFR) to be hiked in the future without contracting the supplies of
reserves and money.
Banks are sitting
on such vast quantities of excess
reserves —
paid to do so by the Federal Reserve as it
pays a relative high
interest rate
on reserves — that the monetary base is larger than M1.
Paying higher
interest rates
on bank reserves may be one method.
Eventually the Fed settled
on an
interest - rate target «range,» with the
interest rate
paid on bank reserves as its upper bound, and a lower bound of zero.
Instead, when the Fed makes its first rate hike — something that probably won't happen until at least September - 2015 — it will do so by 1) raising the
interest rate
paid on bank reserves, 2) increasing the amount that it
pays to borrow money via Reverse Repurchase agreements, and 3) boosting the rate that it offers to financial institutions for term deposits.
The term of the deposit is currently up to 21 days and the
interest rate
paid is slightly above the rate
paid on bank reserves.
The Fed has made several 0.25 % increases in its targeted
interest rates, but the main effect of these rate hikes is to increase the amount of money the Fed
pays to the commercial
banks in the form of
interest on reserves (IOR).
Increases
on the rate you'll get in a savings or money market account typically lag increases in loan rates — and since most
banks have plenty of money in
reserves now, they have little incentive to raise the
interest they
pay.
These include changing
bank reserve requirements by making them higher or lower, changing the terms
on which it lends to
banks through its discount window, and changing the rate of
interest it
pays on the
bank reserves it has
on deposit.
To compel the Fed to switch from its current «leaky floor» monetary control system, based
on paying banks an above - market return
on their excess
reserves, to a more orthodox system in which the
interest rate
on excess
reserves defines the lower bound of a fed funds rate «corridor,» all that's needed is a slight clarification of existing law.
In a floor system,
banks are kept flush with excess
reserves, and monetary control is exercised, not be adjusting the quantity of
reserves so as to achieve a particular equilibrium federal funds rate, but by manipulating the
interest rate the Fed
pays on banks» required and excess reserves holdings, alone or along with the Fed's overnight reverse - repo (ON - RRP) rat
on banks» required and excess
reserves holdings, alone or along with the Fed's overnight reverse - repo (
ON - RRP) rat
ON - RRP) rate.
On Oct. 1, 2008, the Federal Reserve began paying interest to banks on these reserve
On Oct. 1, 2008, the Federal Reserve began
paying interest to
banks on these reserve
on these
reserves.
Free
reserves rose to unprecedented levels following the financial crisis, when the Fed offered to
pay interest on banks» excess
reserves.
These include changing
bank reserve requirements by making them higher or lower, changing the terms
on which it lends to
banks through its discount window, and changing the rate of
interest it
pays on the
bank reserves it has
on deposit.
Currently the Fed
pays interest on the
reserves banks hold at the Fed.
In response the Fed now
pays interest on excess
reserves banks hold at the Fed and uses reverse re-purchase agreements to adjust the fed funds rate target.
(Though I wonder, couldn't the Fed go negative, and require the
banks to
pay them
interest on reserve balances?
These include
paying banks to keep funds parked with the Fed (called «
Interest On Excess
Reserves») or though a different, more complex method of swapping Fed - held debt for
bank cash holdings (called a «Reverse Repo» agreement).
They might link action to actual lending by member
banks and / or quit
paying interest on reserves.
By
paying interest on reserves, central
banks can raise rates as required to prevent inflation without reducing their balance sheets and shrinking the excess
reserves of member
banks.
There is no limit as to how much Credit the
banking system can create through fractional
reserve banking — other than the ability of the borrowers to
pay interest on the money they have been lent.
On Oct. 1, 2008, the Federal Reserve began paying interest to banks on these reserve
On Oct. 1, 2008, the Federal Reserve began
paying interest to
banks on these reserve
on these
reserves.
Free
reserves rose to unprecedented levels following the financial crisis, when the Fed offered to
pay interest on banks» excess
reserves.
This behavior of commercial
banks may be explained by their fear of loan defaults and increased risk aversion, or it may be because of the Fed
paying interest on all
reserves at a rate above the federal funds rate (Simkins 2012).
Ironically, the Fed's policy of
paying interest on excess
reserves may have created a disincentive for
bank lending.
If the central
bank wants to sustain a positive Fed Funds rate, it must either
pay interest on reserves or mop up all excess
reserves.
But in October 2008, the Federal Reserve gained the authority to
pay banks interest on their excess
reserves.
Money does not bear
interest today because central
banks pay interest on reserves.
the most truly inconvenient truth is that the world's economic system, which is based
on fractional
reserve banking (which essentially allows for printing money whenever a government chooses to do so, independent of any real productive value underlying the printed currency), which then requires constant growth to
pay the
interest on ever increasingly debt
on the new «money» that is then used to create loans or government financing of whatever.
Ironically, the Fed's policy of
paying interest on excess
reserves may have created a disincentive for
bank lending.
This behavior of commercial
banks may be explained by their fear of loan defaults and increased risk aversion, or it may be because of the Fed
paying interest on all
reserves at a rate above the federal funds rate (Simkins 2012).