Blinder and the Banks

By Dan Kervick

Alan Blinder, writing in the Wall Street Journal on Tuesday, expresses enthusiasm about some recent hints at a possible change in the Fed’s policy on interest paid on excess reserves. The hints were contained in the minutes of the Federal Open Market Committee’s last policy meeting, which included a passage indicating that most participants in the meeting “thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage.”

Blinder has been a strong proponent of changing the current policy, so he thinks the hinted changes are of the utmost importance. “As perhaps the longest-running promoter of reducing the interest paid on excess reserves, even turning the rate negative,” he says, “I can assure you that those buried words were momentous.”

But I have always found Blinder’s arguments about the importance of the rate of interest on excess reserves to be unpersuasive, and I continue to be puzzled by his reasoning. In the recent piece he again moots the possibility of imposing a negative rate of interest on excess reserves, thus charging banks money to hold them. He then says:

At this point, you’re probably thinking: “Wait. If the Fed charged banks rather than paid them, wouldn’t bankers shun excess reserves?” Yes, and that’s precisely the point. Excess reserves sitting idle in banks’ accounts at the Fed do nothing to boost the economy. We want banks to use the money.

If the Fed turned the IOER negative, banks would hold fewer excess reserves, maybe a lot fewer. They’d find other uses for the money. One such use would be buying short-term securities. Another would probably be lending more, which is what we want.

I am unclear as to how changing the rate of interest of excess reserves could succeed in changing the quantity of excess reserves banks are holding.

Consider an example: Suppose Maple Valley Bank is holding $1 billion in total reserves. Let’s say $750 million of those reserves are held in the form of a reserve account balance at the Fed, and the other $250 million are held as vault cash.  Now let’s suppose that the bank lends Smith $1 million. What happens to the Maple Valley Bank’s total reserves?

Possibly nothing at first.  Assuming Smith maintains a deposit account at Maple Valley Bank, the bank will credit $1 million to Smith’s account. At the same time, it has received Smith’s signed promissory note for $1 million, plus some interest. So Maple Valley Bank has a new liability for $1 million, and it has a new asset worth $1 million and change.

But fairly quickly, Smith will start to spend from the account. Suppose Smith writes a $10,000 check to Acme Dynamite for some explosives. Acme will deposit the check at its bank. Acme’s bank will credit $10,000 to Acme’s account, and settle with Maple Valley Bank, which will result in a $10,000 payment from Maple Valley Bank’s reserve account to the reserve account of Acme’s bank. So one bank now has $10,000 less in its reserve account and another bank has $10,000 more in its reserve account, but total bank reserves haven’t changed.

Smith might choose to make some payments in cash rather than via check or electronically. Suppose Smith takes $200 out of the bank using an ATM card.  Maple Valley Bank’s cash reserves are thus reduced by $200. Over the next few days, Smith spends the $200 on sundry small items. The businesses at which the money is spent collect their cash receipts each day and deposit them in their bank, as a result of which the $200 goes right back into the cash reserves of the banking system, though perhaps at other banks.

I suppose Smith might decide to take some cash out of the bank and keep it under a mattress. In that case, cash withdrawn from the bank does not promptly return to the banking system. But equally, such cash has no stimulatory impact on the economy. And in any case, these kinds of changes in bank customer behavior are likely to be minimal.

So as we can see, apart from relatively insignificant fluctuations in the amount of physical cash held by the public, bank reserves don’t go anywhere when banks increase their lending. They just move in larger volumes from bank to bank. It’s also hard to see why banks would anticipate that they can get rid of their excess reserves by increasing lending, because whatever impact the policy has on a given bank, it will have on all of the bank’s competitors.  If changes in economic conditions cause Maple Valley Bank’s reserve account payments to increase by some percentage, those same conditions will cause Maple Valley Bank’s reserve account receipts from other banks to increase by the same percentage. So it doesn’t appear that these changes in the rate of interest paid on reserves make bank lending any more profitable than it was before.

Blinder seems to be of the opinion that in the days before the Fed paid interest on reserves, the Fed stimulated or inhibited bank lending through quantitative operations, as represented by the textbook money-multiplier model, and that the combination of the financial crisis and the interest on reserves policy has undermined the old system:

… think back to the good old days, when excess reserves were zero. When the Fed injected reserves into the banking system, banks would use those funds to increase lending, thereby creating multiple expansions of the money supply and credit. Bank reserves were called “high-powered money” because each new dollar of reserves led to several additional dollars of money and credit.

The financial crisis short-circuited this process. As greed gave way to fear, bankers decided to store trillions of dollars safely at the Fed rather than lend them out. High-powered money became powerless money.

The Fed compounded the problem in October 2008 by starting to pay interest on reserves. And these days, the 25-basis-point IOER looks pretty good compared with most short-term money rates. If banks were charged rather than paid 25 basis points, they would find holding excess reserves a lot less attractive. As some of this excess central-bank money became “high-powered” again, the Fed would want less of it. So its balance sheet could shrink.

But as we have seen, banks never loaned reserves “out”. Reserves do not leave or enter the banking system in any significant amount when banks increase their lending in the aggregate, so there is no sense in which higher reserve balances resulted from banks “storing” money that otherwise would have gone “out” of the banking system.

Also, the Fed never really managed the pace of lending, to the extent that it was capable of doing so, via quantitative policies – at least not since some failed experiments along those lines in the late 70’s and early 80’s – but by adjusting its target policy rate.  The Fed can manage the quantity of reserves or it can manage the rate at which banks lend reserves to one another. But it can’t manage both at the same time. Once it chooses a policy rate and targets it, then its quantitative decisions are forced by the need to maintain the policy rate.

In the end, Blinder’s message seems to be something along the lines of, “Why not experiment?  What do we have to lose?” And perhaps he is right about that. I have no reason to think that the exact rate of interest paid on reserves is any big deal. But some of the points he makes along these lines undermine his argument. He says:

That said, suppose the policy failed. Suppose the Fed cut the IOER from 25 basis points to minus 25 basis points, and banks didn’t react at all; they just held on to all their excess reserves. In that unlikely event, cutting the IOER would neither provide stimulus nor enable the Fed to shrink its balance sheet. However, the Fed would start collecting about $6.25 billion per year in fees from banks instead of paying them $6.25 billion in interest—a swing of roughly $12.5 billion in the taxpayers’ favor. Some downside.

This is a really puzzling comment. It is especially puzzling from an economist who has been a backer of central bank monetary stimulus, since a contraction of the Fed’s balance sheet is effectively the dreaded “taper” that Blinder has seemed to oppose elsewhere. The Fed is not a private business whose service to the public consists in its success in making profits in the form of positive dollar balances on its balance sheet.  As the branch of the government charged with emitting those dollar balances in the first place, the Fed does not need to “earn” them from some other source.  Nor is it clear that doing so carries a public benefit. Note that if the Fed is earning a net profit, then it is extracting more from the non-government sector than it is injecting into the non-government sector.

This is in fact what has been going on recently. Since the start of the quantitative easing programs, the Fed’s SOMA portfolio has filled up with purchased assets and has grown very profitable. The Fed remitted close to $90 billion to the US Treasury last year, which represents its net earnings after paying its own expenses and making its statutorily required dividend payments to member banks. For all the ballyhoo about the money that QE has been “pouring into the economy” in recent years, QE asset purchases also result in the removal of financial assets from private sector balance sheets, which means those assets stop earning money for the private sector and start earning money for the Fed (which doesn’t need the money). Given that the Fed’s annual earnings have continued to be positive, and are actually now much larger than they were before, we can conclude that the total Fed contribution to the recovery has been a growing net tax on the non-government sector. I don’t know why people are so quick to regard this as a  stimulatory policy.

It is true that the Fed’s net earnings are turned over to the US Treasury. But these remittances have not been accompanied by an expansionary policy, since the Treasury has been reducing its spending, and the remitted earnings have thus merely reduced the government deficit. As emphasized once again yesterday by Scott Fullwiler and Stephanie Kelton, seconding a recent piece by Paul Krugman, the Fed is a part of the US government. As a result, the Fed’s balance sheet and the Treasury’s balance sheet should be viewed in a consolidated manner when analyzing the total impact of government financial transactions on the non-government sector. Similarly, I would argue, the Fed’s income statement and the Treasury’s income statement should be seen as part of a single consolidated income statement. If the Fed is runs a $100 billion surplus (i.e. it has net positive earnings of $100 billion), while the Treasury runs a $1 trillion dollar deficit prior to Fed remittances, then the consolidated government deficit following Fed remittances is $900 biillion. By generating positive earnings, the Fed is effectively collecting a net tax haul for the government and giving it to the Treasury.  So if the Fed increases its earnings by some number of dollars in a given year and the Treasury does not increase its spending by at least the same amount, but instead reduces its deficit, then the net financial result is a fiscal/monetary contraction by the government. I don’t know why Blinder regards that as a good thing, unless what he is really after is deficit reduction, not economic expansion.

One final consideration: It should be observed that a negative rate of interest on reserves appears, in its most direct and immediate effect, to be a slightly deflationary policy. Suppose total reserve balances at the Fed are $1 trillion, and the Fed imposes a negative 1% rate of interest on reserves. At that point the Fed is then draining $10 billion at an aggregate annual rate from bank reserve accounts. Given the high current level of excess reserves this drain probably wouldn’t inhibit lending in the near term, but by the same token, I don’t see why Blinder would expect it to stimulate lending – especially since he thinks monetary policy impacts the banking sector via quantitative means.

Cross-posted from Rugged Egalitarianism

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54 responses to “Blinder and the Banks

  1. We have a fractional reserve banking system. You don’t seem to understand either what excess reserves are or how such a system operates. In a fractional reserve system, banks are allowed make loans against a portion of the funds deposited in them. They are not allowed to make loans against the whole of their deposits. The Federal Reserve specifies what percentage of banks’ total deposits they are allowed to use in making loans. They can loan less than that if they want to, but they are not allowed to loan more than that. The part of a bank’s total deposits that it is prohibited from using for loans is called its required reserves. The part of its total deposits that have not been used for making loans is called its total reserves. If its total reserves exceed its required reserves, it is said to have excess reserves. Excess reserves are the part of a bank’s reserves against which it is still allowed to make loans.

    Now, suppose a bank makes a loan against part of its excess reserves, reducing its excess reserves by that amount. For the moment, let’s keep it simple and assume the borrower deposits the loan back into an account in the same bank.

    The loan is made against money in already existing deposits in the bank. However—and this is the key point—the bank doesn’t debit those already existing deposits in making the loan. It’s still obligated to pay its depositors the full value of their deposits if they want to withdraw from their accounts. So when the borrower deposits the newly loaned funds into an account in the bank, the bank’s total deposits go up by the amount of the loan. Because the loaned funds haven’t left the bank, though, the bank’s total reserves don’t change. (If we assumed instead that the loan was deposited elsewhere, the thing to note would be that, nevertheless, the banking system’s total reserves don’t change.)

    The bank has to hold a certain fraction of its total deposits as required reserves. That portion of its deposits is unloanable. So, when its total deposits go up by the amount of the loan, its required reserves go up as well, even though its total reserves don’t change. When that loan check is deposited in the bank, only a part of it is allowed to go back into excess reserves. The remainder has to be set aside to satisfy the bank’s now increased reserve requirements. So the process of making the loan causes the bank’s total deposits to increase, while its total reserves stay the same, and some of its excess reserves instead become required reserves.

    To sum up, when banks make loans from the excess reserves in the banking system, total reserves in the system don’t change, but total deposits in the system go up. Banks therefore have to hold a larger part of their (unchanged) total reserves as required reserves, leaving fewer reserves as excess from which they could make additional loans. Furthermore, because the money supply is defined to be currency held by the public plus total deposits in the banking system (ignoring just now the details of M1 and M2), the process of making loans will cause the money supply to increase, even though total reserves in the system haven’t changed.

    This is the point. If banks are willing to continue making loans and can find willing borrowers for them, this process—loaning out excess reserves, creating new deposits and so expanding the money supply—can continue until there are essentially no excess reserves left in the system and the whole of the system’s reserves must be held by banks to satisfy their reserve requirements. (At that point, new loans could only be made as old loans are paid off, or when the Fed injects more money into the system through open market operations or whatever.)

    Currently, banks have a huge quantity of excess reserves sitting in their accounts with the Fed, which is paying them a guaranteed rate of interest on those funds. If the economy were roaring along, the private sector would presumably be willing to pay them a better rate for loans made from those excess reserves, and banks wouldn’t just let them sit there. But the economy is not roaring along, the demand for loans is depressed, and banks are content to let the money sit.

    If the interest the Fed is paying on those accounts is any kind of factor in that situation, reducing it, eliminating it, or even replacing it with a fee could motivate banks to try harder to find borrowers. If banks were to succeed in doing that, many of those new loans would be used for new economic activity, the process of new deposit creation would allow the banking system to support a larger money supply from a given quantity of total reserves, and then the Fed could even consider removing some of the money it’s injected into the system in the last five years, knowing that the money supply wouldn’t fall as a result (it would just expand more slowly).

    So, Alan Blinder is right, and since this is not the first post in which you have shown this misunderstanding, you might want to educate yourself on this subject if you intend to continue writing about it.

    • Accepting deposits is only one way a bank’s reserves can grow. And obviously the banking system as a whole cannot increase its reserves in any significant way by accepting deposits since there is little money outside the banking system itself from which the deposited dollars can come. The banking system increases its reserves primarily via transactions with the government, including the Fed. Banks can buy treasuries and either passively earn interest on them, or sell them back at a profit, or they can borrow at the discount window. They also now receive interest payments on existing reserves which continuously augments the total quantity of reserves.

      Banks don’t lend against their deposits. Deposits are the banks’ liabilities, not the banks’ assets. They lend against assets. When they accept deposits their assets and their liabilities are increased at the same time, although the ratio of reserves to deposits increases. Usually taking a deposit from a non-borrower means that deposit balances at some other bank are reduced. So again, bank lending in the aggregate is not stimulated by an aggregate attraction of deposits.

      Paying interest on reserves gradually increases the quantity of reserves. If, as you seem to think, bank lending is stimulated by an increase in the aggregate quantity of reserves, then you should view interest on reserves as a stimulatory policy.

      A bank’s present quantity of reserves, given whatever the current reserve requirement happens to be, is not itself a limitation on a bank’s ability to generate new loans. Any additional reserves the expanded lending requires can be acquired subsequently, during a calculation period and a maintenance period whose clocks begin to tick following the expansion.

      Your picture of banks loaning money “out of” their deposits is seriously out of date at best, and in fact was never accurate. It is based on a simplified stereotype of the fractional reserves system. (To be fair, it is a stereotype that was passed on to me too when I learned economics in college.) Please read the following pieces.

      You say:

      When that loan check is deposited in the bank, only a part of it is allowed to go back into excess reserves. The remainder has to be set aside to satisfy the bank’s now increased reserve requirements. So the process of making the loan causes the bank’s total deposits to increase, while its total reserves stay the same, and some of its excess reserves instead become required reserves.

      I don’t understand in what sense the loan check goes “back into” reserves, whether excess or required. The check is the bank’s liability. If the borrower deposits it in his account, that paper liability is converted into a different kind of liability: a deposit account liability. Nothing goes “back” into the bank’s assets.

      • Dan, I think maybe the key point that George was trying to make is that Blinder was talking about the rate paid (or charged) for EXCESS reserves, not the total of required and excess reserves. So when a bank loans and expands its balance sheet the total value of excess reserves throughout the system decreases even though the total of all reserves remains the same. The Fed does pay interest on both required and excess reserves and currently at the same rate, but that need not be the case. In fact the Fed publishes both rates once a week (see ). Blinder’s argument specifically referred to the rate for excess reserves.

        • Blinder’s argument also assumes that banks today prefer to leave their excess reserves with the Fed at 0.25% rather than seek out creditworthy borrowers at 4% or 10.99% or 22.99%. And that if it were not for that 0.25% they would be out beating the bushes for more business. It makes no sense. It is the borrowers that are choosing not to act, not the lenders.

          • Agreed. And that’s a fine counter-argument to the presumed effects of Blinder’s proposed “incentive”. I was simply pointing out that the proposal itself was not as incoherent with regard to reserves as Dan suggested. About the only real economic incentive the Fed can give these days is in terms of interest rates and Blinder’s proposal is effectively to make them negative for excess reserves. How much additional lending will result from such an incentive is obviously debatable. My intuition is pretty much the same as yours; namely that it would accomplish very little.

    • your understanding of the banking system and of how reserves relate to bank lending is pretty flawed. I suggest reading this paper by Scott Fullwiler:

    • George, I have considered your analysis a number of times and cannot understand, so please let me know what I am not getting.

      Unless the bank’s total reserves already equal its required reserves and the rules are such that the bank must meet its new reserve requirements before making the loan, then under your simple assumption that the borrower deposits the loan back in the bank, the bank always has the necessary required reserves to make the loan.

      Let’s say the bank loans the borrower x and the borrower deposits the x into the bank. The deposits in the bank have increased by x. It’s required reserves have increased by ax with a<1. Since the money has stayed within the bank (under your assumption), then total reserves have not stayed the same but have increased by x, while required reserves have increased by ax. But ax < x, so the bank always has the required reserves.

      • Loans do not create reserves. They only create deposits. The asset for the bank is the loan, which is not part of reserves. When a bank makes a loan, required reserves for the system go up, but those additional reserves must come from the Fed. (Under current law.)

    • George, we had a fractional reserve banking system when we were on the gold standard. That that hasn’t flown for 80 years.Watch Warren Mosler explain it. He opens the talk, and it’s right there.

  2. In theory the banking system as a whole can “get rid of” excess reserves by making more loans. This is because as banks make more loans, the excess reserves become required reserves (or ‘desired’ reserves in a system without official reserve requirements).

    It seems obvious to me that a negative Fed Funds rate would simply lead to mass withdrawals of cash, not more lending or spending.

    • Banks’ reserves include their vault cash, as well as Fed deposits. If the Fed were to charge banks for holding excess reserves, the charge would apply to vault cash as well. If not, then there would be sudden huge increase in the demand for paper currency, and they’d figure it out and make sure vault cash was included in the calculation.

      • banks would pass the negative IOR rate on to their depositors who would probably withdraw a lot in cash or just grin and bear the additional “stimulatory tax” on their money.

        • That’s it! If the bank will store my money for me for free, I’ll leave it in. But if there are no savings accounts that pay interest, but they all have fees instead, or negative interest, I could buy stocks or real estate, which could help me avoid the fees but doesn’t help bank customers in the aggregate, but I might just keep packets of $100’s in my gun safe instead of bits in my savings account. For every $100 bill that leaves the banking system, required reserves go down $10, and excess reserves go down $90.

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  4. Dan, in your reply to George you say:

    “They also now receive interest payments on existing reserves which continuously augments the total quantity of reserves.”

    I don’t think that’s correct. To pay the interest on bonds held by the Fed, the Treasury either sells bonds or taxes (draining reserves from the banking system), and then pays that amount over to the Fed. The Fed then pays some of that amount to the banks as interest on reserves, and sends the rest back to the Treasury, which the Treasury then spends. So overall in this process there is no increase in the quantity of reserve balances held by the banks.

    • No, I don’t believe that is correct. The Fed and the Fed alone pays interest on reserves. It’s purely a matter of central bank policy. And the Fed doesn’t need to get money from some other source in order to pay the interest. Dollars owed by Treasury to the Fed, or owed by the Fed to the treasury are operationally independent of Fed interest payments to the member banks. The Fed is not a private business, and the liabilities side of the Fed’s balance sheet is not operationally constrained by the assets side. Whether the Fed operates with positive balance sheet “equity” or has positive net annual income in any given year depends on a combination of Fed policy choices and economic conditions, and is not an operational requirement for continuing solvent operation. Note that the Fed’s operational financing is independent of the Congressional appropriations process.

      • “the Fed doesn’t need to get money from some other source in order to pay the interest.”

        ok, I get that, but how it works at present is that the Treasury drains reserves from the banking system to pay interest to the Fed, then the Fed adds reserves to the banking system to pay interest on reserves. Overall there is no increase in reserves as a result of IOR, the way things operate currently.

        simple example:

        1. Treasury sells $100 bonds, draining $100 reserves from the banking system.
        2. Treasury pays $100 interest to the Fed (to pay the interest on bonds held by the Fed)
        3. Fed pays $20 interest to banks, adding $20 reserves to the banking system. Fed “remits” $80 to the Treasury.
        4. Treasury spends $80, adding $80 reserves to the banking system.

        So: $100 reserves drained from the banking system, and $100 reserves added to the banking system. Overall there is no increase in the quantity of reserves.

        • How did the Fed get the bond that Treasury then paid off by paying the Fed? It had to buy it from the private sector. So you have left out a $100 reserve add.

          You are right that the interest the Fed pays to the banks decreases its earnings, and so results in less money being remitted to the Treasury. But whether that impacts Treasury spending is an independent fiscal policy question, and is not determined by the Fed’s policy choices.

          • yes the original bond purchase by the Fed adds reserves to the banking system. But the interest paid on reserves doesn’t, at least not the way its done at present.

      • My understanding is that Philippe is correct. The Fed subtracts interest on reserves from the interest remitted to Treasury. I could be wrong, however. It would be good to get a definitive answer on this…

  5. Good points there. One comment though on

    “The Fed can manage the quantity of reserves or it can manage the rate at which banks lend reserves to one another. But it can’t manage both at the same time.”

    That may be true when reserves are in short supply, but I don’t think it’s the case in the current position. If the Fed were to use the IOER rate as a policy tool it could presumably vary the quantity of reserves through QE operations and manage the interbank rate by changing the IOER rate.

  6. Maybe it’s in there and I just wasn’t seeing it, but what is behind the $1.8T in excess reserves, and what would return the level of excess reserves to nearly zero? Is it just QE? Is it a lack of direct investment (or would that have the same effect as lending, leaving money in the banking system virtually unchanged)? I can follow how increased lending wouldn’t make much difference, but what would?

    • I would guess that aggregate excess reserves are a consequence of a lack of T-bills/bonds at a price level low enough to compensate entirely the most risk-averse banker for any perceived risk that the Fed might choose to change its target rate. The Fed could easily drain any such excess reserves, and more, simply by raising its target rate, selling bills/bonds, and tolerating the higher rate of increase in reserves that result from the higher interest rate. So, reduce the stock of reserves but increase the flow.

    • Yes, it is just QE. By definition, QE is the injection of excess reserves, when it is no longer possible to decrease rates (zero lower bound).

      There are two ways those excess reserves could go away. The Fed could drain them by selling securities or not rolling them over as they mature, or they could just stop QE and wait until the required level of reserves rises
      (because of growth of deposits) to meet the actual level.

      • I guess it´s also high time to determine that a rapid expansion(by CB´s) of excess-reserves are the same as printing money. In the “good old days” FED bought corporate-bonds of high grade(as a Lender o L R). Certainly not junk or low grades during crises. Today the c.b´s buy low grade government bonds(which will partly default in coming years…as happened before historically). The only reason the US can manage this…. so far is = currency reserve-status. What currency is big enough to harbour international capital during crisis? None except the dollar. The banks get a free lunch but real reform is nowhere. Business as usual! Still rumours exist that says banks are not to be bailed out(by the FED) next time because of tradinglosses (only deposits will be bailed out). Time will tell.

        Dan says FED is making big bucks for the Treasury. Well yes, easy money out of thin air. FED never values it´s portfolio at market prices. Only by cash-flow. 2,4 B in excess-reserves and expanding. China is selling! Who will buy when FED stops buying and bonds expire? The economy? Dan says that the private sector is selling bonds to FED. Yes and they will probably at some point in the near future increase their selling dramatically due to the low yields and the risk of higher interest-rates(and later default-speculations). Earning more in the private sector! Pensionsfunds are at risk today loosing their capital-reserves.
        How are the FED going to rescue the economy in a deflationary environment? By negative interest?
        You must be kidding! 5 years with negative realinterest-rates has done little. Increasing taxes will not
        do the jobb either. There is now way out when you go to far. And debts are still highly leveraged ueberalles.

      • Another possibility occurred to me: the federal govt. could run a surplus to drain them, taxing them out of existence, correct?

        • Yes, or the treasury could sell bonds in excess of their “funding” requirements to drain reserves, instead of the Fed selling them.

  7. If the Fed were to charge interest on reserves, isn’t it most likely that banks would use their reserves to purchase other assets like commodities, stocks, MBS s, and derivatives. That could really add fuel to asset bubble inflation, though it would add very little to the real economy.

    • It wouldn’t work for the system as a whole. When a bank buys stocks, the money goes into the seller’s bank account, and clearing transfers reserves from one bank to the other. No net change in aggregate reserves.

      Banks would more likely buy treasuries, driving their price up (and yield down) to the negative IOR rate. That is, if the Fed charged 1.1%, they might pay $100.25 for a 3-month T-bill (no coupon). Still, it won’t work in the aggregate, but that wouldn’t stop individual banks from trying.

      • You’re right that it wouldn’t reduce reserves for the system as a whole, but don’t you think individual banks might try to convert their reserves to other assets, say commodities, rather than pay interest on reserves that they don’t need? That too would bid up the price of the assets just like bidding up Treasuries, fueling asset inflation like the housing bubble.

        • Possible, surely. The word is that JPM had a massive short position in silver during the runup to the GFC.

        • James,
          For sure and doing so is also rational from an objective perspective. Charging customer deposit-accounts and/or speculating. Volcker-Rule does not apply? If negative rates will be applied I am sure the stockmarket will run amok. A doubling 1-2 year is possible. Long TSys-rates will also explode to the upside when capital leaves the public sector(i.e government paper), pensionsfunds included. The most craziest thing a centralbanker can think of. Shooting themselves in the foot.

      • Yes, the banks will problably also start buying TSys if IOER-rate goes negative but the overall market will soon change due to alternative yields; stockmarket and other. Ok let´s assume there will be a run from todays 2,8% on a 10 y tsys down to 1,8%. Great returns and back to april´s level. Will i.e pensionfunds feel satisfied? Hardly. They will sell more bonds and drive rates up again. An so will others. Another negative IOER-rate cut? And again.. and again? Somewhere and sometime down the line the banks(and the FED) risks being outmanouvred by the MARKET. But a Japan-situation is already here. In fact Japan was even more successful than US(today) during their first 5 years behind 1989. Then let us hope China today represents the US back in the 90-s(as world economic engine). In Europe Merkel has to go to the court before Draghi can start any QE. Elections in the EU coming up in spring! Interesting times indeed.

  8. Dear Dan Kervick,
    I do agree with You in respect of how money floats inside USA´s own national clearing-system.
    But don´t you forget 2 other possibilities; how banks can use their exess-reserves home and abroad by speculating/investing themselves! I guess QE-money has been flooding China as a weapon to strengthen the Renminbi! I also believe QE-dollars are being used by banks for investments and trading in Europe etc. When an american bank takes money abroad their account-balance at the FED is debited. Instead there have to be a clearing between other centralbanks and the FED! And I guess this international clearing will not affect the account of the american bank or at least not their excess-reserves which! When money leaves the border the money-supply shrinks! In this case not the US M3 but instead a part of the monetary base. You could say the commercial banks use centralbank money for their own purpose(except lending to their domestic economy). Money exported by the banks abroad could comeback as a “savingsglut” from China etc which is not exactly the same as an account-clearing between centralbanks.

    With a negative IOER I suppose the asset-speculators(i.e banks) will start feasting and a stockmarket-bubble will form in no-time.


    • Foreign central banks have accounts at the Fed, just like US private banks do. So the question is what happens when balances transfer from US banks to foreign bank accounts, as a result of the US bank buying a foreign asset. (BTW, the same thing happens as a result of the US trade deficit.)

      The dollars end up in the foreign central bank’s “checking” account at the Fed. Since foreign CBs generally prefer to hold Treasuries, they would buy them, and the dollars would then flow to the US bank account of whoever sold them. No change in the aggregate level of reserves held by US banks.

      Aggregate reserves go up and down only by transactions between the US government (Fed or Treasury) and the non-government sector. They go up when the government buys things (goods and services, or bonds) or otherwise transfers money (e.g., Social Security) and go down when the government sells things (usually bonds), or collects taxes.

      • Thank You for explaining how a national monetary base fits into an international one. But my intention was to show how banks can use their excess-(cash)reserves to stimulate lending outside the US or by buying assets in US for i.e rehypothecation in the Repomarket etc. By doing so they will increase financial lending and asset-prices incl money-supply both in the US and abroad without affecting real money-velocity very much(aka production). So when excess-reserves leaves the country they return instantly as (demand-)reserves….but not as excessive ones due to the fact that investing abroad as well as at home demands a fraction of reserves in it self(say 10% only). Is not this process more like a multiplier in financial speculation? And with negative rates…..uhhh!

        By the way…to my knowledge there suppose to be an Eurodollar-market which is not originally part of the european centralbank´s accounts with the US FED! That´s why the name Eurodollar. Some people says the difference between M3 and MZM partly involves Eurodollars. I guess such a statement depends on maturity and holder of these dollars. CB-money are most liquid. Eurodollar are not the same here.

    • Christer, here is the former Deputy Secretary of the Treasury, Frank Newman, in his recent book Freedom From National Debt, April 2013.

      People sometimes speak of China and Japan “sitting on a pile of dollars” and “lending” money to America, but in truth, nations with dollar trade surpluses must keep those dollars in the U.S., either by buying American goods and services or by holding dollar assets like U.S. Treasuries. When oil is sold in dollars, the oil-producing nations either spend the dollars or invest them in USD assets, and the dollars ultimately go to either buying American goods and services or investment in the U.S. – often in Treasuries. Some nations hold dollars as a reserve currency with the expectation that others will always want dollars, but when they do, the dollars remain in America. When a foreign bank receives dollars, it really means that bank has dollars on deposit with an American bank. All the dollars paid by Americans to companies, people, governments, or investors in other countries stay in the U.S. financial system. It is not possible for foreign nations to take dollars out of the U.S. financial system.
      The Treasury market is very, very big and deep. The largest foreign owners of Treasuries might, in a month, increase their holdings by a total of about $ 25 billion. During that month, typically $ 10 trillion of Treasuries will be traded.

      There are large amounts of international assets owned by Americans as well as U.S. assets owned by foreigners: while foreigners own nearly $ 23 trillion of American assets, including the international reserves that many countries hold in U.S. dollars, Americans own more than $ 20 trillion of foreign assets. So, foreigners own about a net $ 3 trillion of USD assets (out of a total of about $ 200 trillion); that amount can be in many forms: deposits in U.S. banks, Treasuries, corporate bonds, stocks, real estate, etc. If some foreign investors decide to shift their mix of U.S. dollar assets, it just means that U.S. domestic investors exchange some other USD assets for some USD assets owned by foreigners. The proportion held at any time in Treasuries or any other class of assets by any particular set of investors does not really matter.

      Also this:

      The system marvelously balances itself every day – with help from the Fed, in its role as central bank, which provides flexibility for timing differences, frictions, etc. The Treasury and the Fed are both parts of the U.S. government; they have different responsibilities within the U.S. financial system, but often work together.

      When the Treasury makes distributions, then replenishes its Fed account by issuing new securities (in addition, of course, to collecting taxes), then total financial assets increase, but there is no change in the money supply or in equity risk or credit risk in the financial system. This process is illustrated in Appendix B.

      In the process of Treasury issuance and redemption, the money involved changes hands but cannot leave the U.S. financial system. There is a huge, deep market for Treasuries, with an average of over $ 500 billion per day traded. Typically when the Treasury issues securities, it has already distributed funds to the bank accounts of investors redeeming securities and to recipients of government payments, from the Treasury account at the Fed. Treasury has been generally keeping about $100 billion, sometimes up to $300 billion, on deposit at the Fed— that is in addition to the hundreds of billions of other assets, including gold and silver, held by the Treasury. . . . Generally, the Treasury uses bank money newly received from tax collection and Treasury issuance to replenish its deposit accounts at the Fed.

    • Christer, see my comment above. American banks can’t let US dollars leave the US financial system. By law.

  9. Dear Dan,

    Missed a few words in my comment above at 12:35.

    Wrote: “And I guess this international clearing will not affect the account of the american bank or at least not their excess-reserves which!” Sentence not completed

    Should be: “…….execess reserves by the FED which were reduced in the first place by the amount that was transmitted abroad!”

    • Christer, in real life, “transmitted abroad” means going from one column on the Fed’s spreadsheet to another column. That’s all. From Mark’s bank account to Michel or Merkel’s bank account. From the seller to the buyer. . .no matter what the product or service, as long as it’s sold in USD.

      [If you want to buy some in Yuan, you have to do what China and everyone else has to do: go on the open market and exchange USD for Yuan. But the bucks stay here.]

      • What am I? Brain dead? From the buyer to the seller. Sorry about that.

      • MRW, thanks for extra insights. But my point(except the Eurodollar-market) was about “exported” money-multiplier effects coming from US banks using their excessive-reserves abroad. In that respect US excess-dollars are (exchanged for i.e. loans in Euros etc) benefitting US banks and economies outside US. Even buying foreign assets incl stocks leads to less productive use of american capital. Blinder talks about negative rates to stimulate the domestic economy. For that to happen american firms och households have to be involved some way or another, borrowing/investing/hiring and producing/consuming! And banks are the intermediaries. If US banks(and shadowbanks) instead invest for themselves abroad with “free money” that is not really productive. On the contrary in fact except if there where i.e lack of capital. Nevermind that the level of dollars are the same, or not. A monetary base is supposed to give boost to the national economy showing increasing investments taking place. Money-supply- aggregats like M2/MZM are indicators but real productive capitalallocations should always be measured by the investment-level. Everything else can be illusions in todays financialized world. Domestic investment in the US has been slowing all the way since the 80-s. So has income. But not debt I am afraid.

        Above people are discussing how exess-reserves could be reduced by the FED. And it seems they are reducing the matter as it would be all about how it can be done technically. No one even talks about the huge risks involved doing so, i.e just stopping/taper QE without congress pulling their acts together(soon comes the next budgetcliff). And maybe in a moment where the FED suddenly decides to stop paying interest on reserves. Interest are on the move uppwards since april mainly due to bankrisks i Europe, capitalflights to the US(/Germany) and flight from public investment due to insolvence-risks. Stockmarkets benefits since long already.

  10. Pingback: Blinder and the Banks « Economics Info

  11. Sorry I haven’t been able to join in the conversation everybody. I’m coming down with a cold and my brain isn’t working well today.

  12. Dan,
    I have to agree with Nick. Used to be the Fed could control the rate or the quantity but not both. Now the Fed can set the rate by paying interesting on reserves and charging a slightly higher rate for overdraft (discount window). The quantity would no longer matter. The US still requires a 10% reserve but some countries do not. In those countries banks determine how much reserves they keep. I guess it is enough to perform clearing operations (the true purpose of reserves) without getting an overdraft charge.
    MMT often exploits Japan to show deficits do not cause inflation, default, high interest rates, etc. MMT should also exploit the Canadian system to show increasing reserves deso not cause banks to increase lending. Canada imposes no minimum reserve requirements. Bank lending in such a system could explode (the inverse of a minimum of 0% is infinity (technically undefined but you know what I mean)). So why doesn’t bank lending increase without bound in Canada? Because MMT says bank lending is not reserve constrained. It is based on credit worthy customers and banks willing to lend to them.
    Hope you feel better.

  13. Reserves are supposed to be banks assets, but if they cannot earn interest with them they stop being assets and become liabilities instead. Why would a bank accept any payments if all it gets is more liabilities?

    As nice it would be to cut off this ‘risk-free return on money’ we need proposals that produce working banking system.

    • I’m not sure just how an asset becomes a liability on a banks books, but just because it costs money to maintain something doesn’t automatically make it a liability, does it? It must cost the bank money to maintain its buildings and grounds, but that doesn’t make them liabilities. What’s your take, golfer1john?

      • We went to a White Elephant Christmas party last week. The term originated in Siam. If one of the courtiers was obnoxious to the King, the King would give him a gift of a white elephant, which the courtier would have to maintain (you can’t escape the honor of a gift from the King), and the cost to maintain it was far in excess of its value, so the courtier would be financially ruined by the gift.

        I think PZ is not using the term “liability” in the strict accounting sense. Just like the white elephant is an asset, excess reserves could be an asset that has a cost in excess of its benefits.

        The interest the bank would pay is an expense, not a liability, again using the language of accounting. In everyday language, the terms are often interchangeable.

        • Thank you golfer1 for both the example and the description. I think you’re spot on about the source of the confusion being everyday language.

  14. Ok, I get the message from Mr Moderator!(2 replies sent off to digital space/junkyard)

    Few are willing to discuss the implications of Mr Blinder´s ambition/proposals. Never mind his ev. missassumtions about bankreserves at the centralbank and their division between restricted and excessive. It is all about capitalformation and allocation. In the US(banks) loans to deposits are 0,7 and sinking. In Sweden the same ratio is above 2 and growing. A small country depending on foreign capital to blow its house-bubble another level higher. Just like the US, politicians are demanding that their centralbank and the monetarists will put an end to the misery(unemployment and lack of growth). Impossible I would say. Debtleverage is still an obstacle as is to low yields.

    Of course I will stop posting my views here from now, thank you!

    • Stephanie Kelton

      It’s nothing personal. The moderator has been studying for (and taking) finals. The rest of us have been grading them. Nothing sinister. Sorry for the delay.