Banks are required by law to hold a certain fraction of their deposits in reserve accounts at the Fed, but receive no interest on these deposits. Having the authority to pay interest would solve two technical headaches for the Fed. If they earned interest from the Fed, banks would have no incentive to lend out excess reserves for less. That would make the Fed’s benchmark federal-funds rate, which banks charge on overnight loans to each other, less likely to plunge below the Fed’s official target — now 2% — on days when the banking system was awash in cash. In addition, the Fed could theoretically combat the credit crunch by buying securities or extending loans without limit without causing the federal-funds rate to fall to zero, something that could fuel inflation or distort markets.
In other words, the concerns were that banks would hold too few reserves and that we would end up with higher inflation. But today’s concerns seem to be that banks are holding onto too many reserves and that we may be in for a deflationary spiral and inadequate aggregate demand.
This post also noted that Congress originally intended for interest to be paid on reserves starting in 2011 out of concern that the government might lose income to private banks. While pumping a few extra millions of dollars into the private sector right now might be good Keynesian economics, perhaps delaying this new policy until 2011 would have been better given the collapse of the money multiplier.
3 comments:
The US Government wants the US taxpayer to pay interest on private bank reserves. On funds that the taxpayer does not use??
This is a solution to what problem!? It can't solve the problem of too much liquidity because the cause of the problem is the existence of huge pools of unregulated money in the global economy in the first instance. To fix that would require a global effort to deal with stateless corporations.
Here's an excerpt from Michael Moffit's 1983 book 'The World's Money - International banking from Bretton Woods to the Brink of Insolvency'. It explains when and how things got out of control. The process of 'disintermediation' - large global corporations could evade national controls through intra-corporate borrowings across national boundaries. They could play off the banks to force higher interest payments on their deposits etc. As you will read, national monetary policy looks like it is is only effective against small business and households, leaving the large corporation with an ongoing unregulated source of cheap finance. Providing interest payments on bank reserves is just what the banks want but is rather irrelevant to the problem at hand.
"Ever since 1966 US banks have resorted to the Euromarket as a source of funds.
“Ever since the credit crunch of 1966, US banks have resorted to the Euromarket as a source of funds whenever the Fed tightened monetary policy at home. In 1966, banks tapped the fledgling Euromarket when the Fed clamped Regulation Q ceilings on domestic interest rates. When the Federal Reserve refused to lift the ceilings on the interest rates banks could pay on the certificates of deposit, the large banks that had operations in London issued Euro-CDs as an alternative source of funds. The banks’ Euromarket branches loaned these funds to New York, which used them to sustain credit expansion at home. In 1969, when Federal Reserve policy turned restrictive in a belated attempt to combat Vietnam-related inflation the banks played the Eurocard again. By then more banks were involved and they were more experienced at it. In 1969, US banks borrowed about $15 billion from their Euromarket branches in order to maintain credit expansion at home.
Probably the greatest example of how banks use their global reach to undercut US monetary policy came in 1979. Prior to the announcement of the October 6 measures, US banks had been borrowing heavily in the Euromarket (particularly from their own subsidiaries) to expand credit in the United States. Domestic loan demand was strong (in part because low real interest rates encouraged borrowing) and with the proceeds of new OPEC price increases pouring into the Euromarket, it made sense for banks to borrow in the Euromarket to relend at home. The Federal Reserve Board calculated that “US banks borrowed $30 billion from their foreign branch offices during the first three quarters of 1979.” The Fed had been tightening monetary policy and interest rates were rising, but the huge flow of Eurodollars in the US economy was fueling credit expansion. In the summer and early fall of 1979, according to the Fed, imported Eurodollars and other exotic bank liabilities financed about “half the increase in bank credit over that period.” Volker correctly perceived that to control inflation, it was necessary to get a handle on bank credit expansion. Thus on October 6, he did take some steps to reduce the flow of Eurodollars to the US economy, placing reserve requirements on US banks’ Eurodollar borrowings.
While bankers universally supported Volker’s October 6 inititiatives, in the ensuing months they flaunted their extra-terrritoriality and directly undermined the effectiveness of the October 6 measures. Less than a month after the October 6 package, Rimmer de Vries of Morgan Guaranty told the Joint Economic Committee how US banks could get around the new reserve requirements by lending directly to the foreign subsidiaries of the US-based companies. The multinationals, over which the Fed has no control, could then brink back the funds to the United States with no questions asked. Chase Manhattan’s London branch, for example, could lend to an Exxon subsidiary in Europe which could transfer the funds to New York for use in the United States. Other forms of financial innovation were also used. According to de Vries, blue chip borrowers could tap nonblank channels of credit, such as the commercial paper markets in New York and London. Finally, foreign banks could lend directly to US companies and Volker could only protest. As Litton Corporations’s treasurer, Charles Black, observes, “There are so many ways to borrow that big, sophisticated companies can use. It’s awfully hard to control this kind of thing. There are too many things you can’t plug up.”
Despite the Fed’s October 6 measures, bank lending to their corporate customers remained high. Albert M Wojnilower of First Boston Corporation points out that loan commitments by banks to their corporate clients actually increased after the October 6 policy change, as corporations moved to insulate themselved from the potential imposition of credit controls. The banks reduced the availability of credit to noncorporate borrowers in order to maintain credit commitments to their top corporate customers. As for the effectiveness of the Fed’s new monetarist policies Wojnilower concludes that they “exerted no perceptible influence” on bank lending….”
‘The World’s Money – International banking from Bretton Woods to the brink of insolvency’ by Michael Moffitt. Touchstone Book, Simon and Schuster New York. 1983. ISBN: 0-671-50596-3 Pbk. Pages 206-207.
Taxpayers are not the ones paying the interest on these deposits. The Fed is, although the way things are going, the Treasury is sort of funding the Fed these days, rather than the other way around, although ultimately this means the Chinese central bank (not the foreign subsidiaries of the US MNCs). Things have definitely gotten pretty funkily weird lately...
although ultimately this means the Chinese central bank (not the foreign subsidiaries of the US MNCs).
I have looked at the US Treasury data at:
http://www.treas.gov/tic/mfh.txt
It says 'China' but doesn't mention any more than this. Is there a source for more detailed information?
What would rule out, say, a US TNC subsidiary in China purchasing US Treasures (from China) as coming up under the general heading of 'China' in that table??
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