# Floored! ## Metadata * Author: [George Selgin](https://www.amazon.comundefined) * ASIN: B07MWJMK1F * ISBN: 1948647087 * Reference: https://www.amazon.com/dp/B07MWJMK1F * [Kindle link](kindle://book?action=open&asin=B07MWJMK1F) ## Highlights The fed funds market served in those days mainly as a means by which banks in danger of falling short of their minimum reserve requirements could make up for reserve shortages by borrowing from banks with reserves to spare.1 Because bank reserves didn’t bear any interest, and the fed funds rate was always positive, banks with surplus or “excess” reserves were always happy to lend those reserves overnight. — location: [181](kindle://book?action=open&asin=B07MWJMK1F&location=181) ^ref-16785 --- As far as the Fed’s day-to-day operations were concerned, monetary control was a matter of adjusting the supply of federal funds to make the funds rate land on target. To do that, the Fed relied upon “Open Market Operations,” meaning purchases or sales of government securities, and short-term Treasury securities especially, from a score or so of approved (“primary”) security dealers. — location: [208](kindle://book?action=open&asin=B07MWJMK1F&location=208) ^ref-8071 --- Interest on reserves, Kohn said, Would act as a minimum for overnight interest rates, because banks would not generally lend to other banks at a lower rate than they could earn by keeping their excess funds at a Reserve Bank. Although the Board sees no need to pay interest on excess reserves in the near future, and any movement in this direction would need further study, the ability to do so would be a potentially useful addition to the monetary toolkit of the Federal Reserve — location: [291](kindle://book?action=open&asin=B07MWJMK1F&location=291) ^ref-56540 --- As events would show, paying interest on excess reserves (IOER) could actually undermine both efficiency and monetary control by causing banks to accumulate unlimited quantities of such reserves. — location: [296](kindle://book?action=open&asin=B07MWJMK1F&location=296) ^ref-31403 --- In an orthodox corridor system, a variable but generally positive interest rate on bank reserves, rather than a zero rate, serves as a lower bound for the central bank’s policy rate, while the central bank’s emergency lending rate serves as an upper bound. Although the policy rate can vary within these limits, it generally stays close to a target set, in the most common “symmetrical” corridor arrangements, halfway between them.7 To keep the overnight rate on target, the central bank relies on a combination of open market operations and changes to the administered rates that define the corridor’s lower and upper bounds, where open market operations alter the supply of, and the administered rate settings the demand for, overnight funds. — location: [300](kindle://book?action=open&asin=B07MWJMK1F&location=300) ^ref-35157 --- Indeed, the Fed’s “Great Moderation” operating system, discussed earlier, might be described as a corridor system of sorts, albeit one that involved an asymmetrical and variable corridor based on a zero IOER rate and a discount (“primary credit”) rate set at a fixed spread above the federal funds rate target.8 As we’ve seen, in that regime the Fed relied on open market operations to achieve its policy target. Had the Fed employed interest on reserves to establish a proper corridor system, as it planned to do in 2006, and even had it allowed interest to be paid on excess reserves with that aim alone in mind, paying interest on reserves wouldn’t have constituted a radical change. But as we shall see, when the Fed finally put its new tool to work, a corridor system was no longer what it had in mind. — location: [309](kindle://book?action=open&asin=B07MWJMK1F&location=309) ^ref-52840 --- We had initially asked to pay interest on reserves for technical reasons. But in 2008, we needed the authority to solve an increasingly serious problem: the risk that our emergency lending, which had the side effect of increasing bank reserves, would lead short-term interest rates to fall below our federal funds target and thereby cause us to lose control of monetary policy. When banks have lots of reserves, they have less need to borrow from each other, which pushes down the interest rate on that borrowing—the federal funds rate. — location: [339](kindle://book?action=open&asin=B07MWJMK1F&location=339) ^ref-28378 --- Although their meaning may seem surprising in light of subsequent developments, these official statements, as well as many others like them, make it clear that the Fed’s main concern in October 2008 was that of avoiding an unplanned loosening of what it still considered an appropriate monetary policy stance. Although they were keen on providing emergency support to particular firms and markets, Fed officials recognized no general liquidity shortage calling for further monetary accommodation. The challenge, as they saw it, was that of extending credit to specific recipients without promoting a general increase in lending and spending. — location: [357](kindle://book?action=open&asin=B07MWJMK1F&location=357) ^ref-10821 --- Just how an IOER rate set 75 basis points below “the lowest targeted federal funds rate” could do that, and specifically how it could keep the effective fed funds rate from eventually slipping as much as 75 basis points below the Fed’s stated target, the Board’s press release didn’t explain. Nor could it have, since IOER could only keep the fed funds rate from falling below the Fed’s target if the IOER rate was set equal to, or rather (for reasons we’ll come to) above, the target. Partly for this very reason, the effective fed funds rate continued to decline. — location: [381](kindle://book?action=open&asin=B07MWJMK1F&location=381) ^ref-45136 --- By November 6 the effective fed funds rate had plunged to just 23 basis points—far below the Fed’s 100 basis point target. That IOER failed to keep the fed funds rate on target even after the IOER rate was set equal to that target was both inconsistent with the way a floor system was supposed to work and a source of considerable disappointment to Fed officials and staff economists. Blame for it has been placed on the fact that, in addition to banks, various government-sponsored enterprises (GSEs), including Fannie Mae, Freddy Mac, and the Federal Home Loan Banks, keep deposit balances at the Fed but aren’t eligible for interest on those balances.10 The GSEs’ access to the fed funds market therefore created an arbitrage opportunity Fed officials hadn’t anticipated, with GSEs lending fed funds overnight to banks, — location: [415](kindle://book?action=open&asin=B07MWJMK1F&location=415) ^ref-6605 --- When, in mid-December 2015, the Fed introduced a new overnight reverse repo agreement (ON-RRP) facility to create what Stephen Williamson (2016) calls a “floor-with-sub-floor” system, with the effective fed funds rate trading between the IOER rate floor and the new ON-RRP subfloor, the resemblance of the Fed’s new system to a corridor system gone topsy-turvy became complete. — location: [428](kindle://book?action=open&asin=B07MWJMK1F&location=428) ^ref-4272 --- A floor system can likewise allow the Fed to steer the fed funds rate any way it likes, while stepping on the reserve-creation pedal as hard as it likes, only by putting the usual monetary transmission mechanism in neutral. For the usual zero lower bound liquidity trap, it substitutes an above-zero liquidity trap in which monetary policy remains, despite appearances to the contrary, more or less equally impotent. — location: [513](kindle://book?action=open&asin=B07MWJMK1F&location=513) ^ref-41925 --- The Fed’s decision to switch to a floor system at a time when equilibrium market interest rates were collapsing, and to do so with the aim of propping up its policy rate to keep it above a presumed zero lower bound, contributed to the severity of the recession while limiting the Fed’s options for promoting recovery. Thanks to it, the U.S. economy remained in the grip of an above-zero liquidity trap years after the nadir of the financial crisis, making the Fed’s asset purchases far less effective than they might otherwise have been at reviving overall lending and spending, or at keeping inflation on target. Indeed, as Maria Arias and Yi Wen (2014) explain, because it involved large-scale purchases of long-term debt, and a consequent flattening of the yield curve, Quantitative Easing may actually have reinforced the floor-system-based, above-zero liquidity trap. — location: [533](kindle://book?action=open&asin=B07MWJMK1F&location=533) ^ref-53458 Super interesting commer- and worth revisiting and understanding better. --- Until then, stimulating the economy simply wasn’t on their minds. Instead, their concern was to avoid stimulating the economy unintentionally, and IOER, administered according to the requirements of a floor system, would serve that end well. Alas, in retrospect it seems to have served it all too well. — location: [542](kindle://book?action=open&asin=B07MWJMK1F&location=542) ^ref-44201 --- the presence of the primary credit rate is a glaring anomaly, for that’s the discount rate that the Fed charges sound banks for short-term emergency loans. As such, it isn’t a market rate at all but one set administratively by the Fed’s Board of Governors. — location: [633](kindle://book?action=open&asin=B07MWJMK1F&location=633) ^ref-51330 --- Because banks that were once regular participants in the fed funds market no longer had reason to manage their liquidity by means of overnight lending and borrowing, they also lacked an important former reason to scrutinize one another and to thereby contain systemic risk, to wit: a desire to avoid incurring losses on unsecured loans. Economists Jean-Charles Rochet and Jean Tirole (1996, p. 735) were among the first to draw attention to the advantages of interbank peer monitoring, while warning that, insofar as it discourages such monitoring, “government intervention . . . destroys the very benefit of a decentralized [banking] system”: — location: [676](kindle://book?action=open&asin=B07MWJMK1F&location=676) ^ref-13527 --- despite extreme market stress, sophisticated lenders were able to inform themselves of banks’ creditworthiness and, by signaling that creditworthiness by driving less worthy banks out of the CD market, to supply useful information to other lenders. — location: [701](kindle://book?action=open&asin=B07MWJMK1F&location=701) ^ref-1417 --- Finally, a recent study by several Dutch economists (Blasques, Bräuning, and Lelyveld 2016) finds that bank-to-bank monitoring contributed to a significant decline in interbank credit risk uncertainty, and a corresponding increase in the volume of interbank lending, on the Dutch interbank market. Its authors also report what they refer to as a “multiplier effect” of banks’ peer monitoring efforts, whereby lenders were inspired to redouble their monitoring efforts as the perceived risks of interbank lending declined, because the decline in risk made it worthwhile for them to widen the set of counterparties with which they might choose to interact. Lastly, the authors explain that a relatively wide interest-rate corridor is crucial to the encouragement of interbank monitoring. — location: [708](kindle://book?action=open&asin=B07MWJMK1F&location=708) ^ref-49622 --- consider policies that increase the rate differential between the interbank market and [its] standing facilities for depositing and lending funds. Only then is the interbank market profitable enough to encourage intense peer monitoring and search among banks — location: [714](kindle://book?action=open&asin=B07MWJMK1F&location=714) ^ref-52781 --- The Fed’s decision to pay interest on excess reserves, and the ensuing growth in banks’ excess reserve balances, therefore appear to have been the fundamental cause of the enduring post-Lehman decline in interbank lending. — location: [724](kindle://book?action=open&asin=B07MWJMK1F&location=724) ^ref-31653 --- Finally, it was not only in the United States that the switch from a corridor-style to a floor-style operating system coincided with a marked decline in interbank lending. The same thing happened elsewhere where floor systems were resorted to, including Norway (Sellin and Åsberg 2014), the UK (Winters 2012, p. 40), New Zealand (Selgin 2018), and the Eurozone (Garcia-de-Andoain et al. 2016 and van den End 2017). According to Bill Winters (2012, p. 40; see also Jackson and Sim 2013, pp. 225–26), after its own switch to a floor system in March 2009, the Bank of England found that it had become other UK banks’ “preferred counterparty” for short-term lending, “disintermediating the interbank money market and thereby inhibiting interbank money market activity.” — location: [734](kindle://book?action=open&asin=B07MWJMK1F&location=734) ^ref-6296 --- European banks’ “diminished appetite for [interbank] lending” in turn created an even larger dependence on central bank funding by banks with a liquidity shortage. So bank behavior act[ed] as a feedback mechanism, reinforcing the transition to a floor system. That the floor system has persisted for nearly eight years now indicates . . . a critical transition to a new equilibrium [in which] central bank liquidity supply has crowded out private intermediation — location: [744](kindle://book?action=open&asin=B07MWJMK1F&location=744) ^ref-33783 --- until these changes came about, the fed funds market had long served as “the most immediate source of liquidity for regulated banks in the U.S.” Consequently, any disruption of that market could “lead to inadequate allocation of capital and lack of risk sharing between banks.” In extreme cases, they add, it might “even trigger bank runs.” — location: [755](kindle://book?action=open&asin=B07MWJMK1F&location=755) ^ref-43843 --- by establishing a floor system, the Fed, which is supposed to serve as a lender of last resort, became a short-term borrower of first resort, destroying in the process the interbank lending market that had long served as banks’ traditional, first-resort source of last-minute liquidity. — location: [758](kindle://book?action=open&asin=B07MWJMK1F&location=758) ^ref-39813 --- importantly, those modest IOER rates weren’t modest relative to comparable market rates. For that reason, their influence on banks’ behavior has been anything but trivial. — location: [791](kindle://book?action=open&asin=B07MWJMK1F&location=791) ^ref-9045 --- primary dealer banks simply refrained from letting go of reserves they acquired. That practice was, of course, quite contrary to what primary dealers were normally expected to do, and to what they generally did do before the crisis, when the Fed was still relying on its traditional means of monetary control. Indeed, in the early stages of the subprime crisis, Fed officials worried that the collapse of ailing primary dealers would prevent them from serving as reliable conduits through which fresh reserves would make their way from the Fed to the rest of the banking system (e.g., Kohn 2009). Now, paradoxically, IOER was itself serving to close the same conduits, along with much of the rest of the interbank market, and was doing so deliberately as part of the Fed’s new monetary control strategy. — location: [832](kindle://book?action=open&asin=B07MWJMK1F&location=832) ^ref-2319 --- because many of their (mostly European) parent companies enjoy much lower net interest margins than U.S. banks, foreign bank branches have found it especially profitable to acquire fed funds for the sake of arbitraging the difference between the Fed’s IOER rate and lower private-market interest rates. — location: [847](kindle://book?action=open&asin=B07MWJMK1F&location=847) ^ref-32400 --- Ordinarily, McKinnon continued, banks can cover their unexpected reserve shortfalls by borrowing funds from other banks on the interbank market. But banks with surplus reserves may “become loath to part with them for a derisory yield,” while those that find themselves short “cannot easily bid for funds at an interest rate significantly above the prevailing interbank rate without inadvertently signaling that they might be in trouble.” — location: [858](kindle://book?action=open&asin=B07MWJMK1F&location=858) ^ref-52705 --- During the notorious Weimar hyperinflation, for example, the (proportional) growth in German bank reserves far exceeded that witnessed in the United States since Lehman’s bankruptcy. Yet according to Frank D. Graham (1930, p. 68), Germany’s banks, far from accumulating excess reserves, increased their lending more than proportionately. “It would appear,” Graham writes, “that the commercial banks extended loans throughout the period of post-war inflation considerably in excess of a proportionate relationship with the increase in the monetary base. . . . The increase in deposits issuing from loans was especially marked in 1922 and till stabilization in 1923.” — location: [920](kindle://book?action=open&asin=B07MWJMK1F&location=920) ^ref-50451 The reason monetary expansion did not lead to hyperinflation is because HER and the floor system caused hoarding. --- It doesn’t follow, of course, that in the absence of interest on excess reserves, the Fed’s post-Lehman asset purchases would have led to hyperinflation. Had banks not been inclined to hoard reserves, Fed officials would not have dared to purchase assets on such a large scale: had they tried doing so, they would have been compelled to end the purchases as soon as it became evident that the rate of inflation was in danger of exceeding the Fed’s target. As it was, by relying on IOER to discourage banks from dispensing with excess reserves, the Fed ended up falling short of, instead of surpassing, its inflation target. That outcome came as a surprise to those accustomed to the workings of the Fed’s traditional monetary control framework. But in the context of its new floor framework, any tendency for the Fed’s asset purchases to raise prices would itself have been surprising. — location: [924](kindle://book?action=open&asin=B07MWJMK1F&location=924) ^ref-1833 Related to the note on hype, nffation. Something charged during 2008 that fundamentally dinged the dynamic. --- Others may wonder whether, rather than being due to excess reserves’ high yield relative to other assets, banks’ continuing willingness to hold substantial quantities of such reserves has been a result of their need to satisfy Basel’s Liquidity Coverage Ratio (LCR) requirements. The Basel requirements, which were first applied to U.S. banks at the beginning of 2015, call for bank holding companies having at least $250 billion in assets, or ones with $10 billion or more in foreign exposure, to maintain a level of “… — location: [932](kindle://book?action=open&asin=B07MWJMK1F&location=932) ^ref-16513 --- Zoltan Pozsar (2016, pp. 2–3), for one, appears to take this view. “Contrary to conventional wisdom,” he says, “there are no excess reserves—not one penny”: Labelling the trillions of reserves created as a byproduct of QE as “excess” was appropriate only until the Liquidity Coverage Ratio (LCR) went live, but not after. . . . Before the LCR, excess reserves were indeed excess: every penny was in excess of the amount of reserves required by the Federal Reserve’s Regulation D. Under the LCR, all excess reserves became required: not to comply with Regulation D, but with the LCR. . . . It is helpful to think about the LCR as a global reserve requirement regime. .… — location: [939](kindle://book?action=open&asin=B07MWJMK1F&location=939) ^ref-22928 --- But is it true that the LCR “does not allow” banks to get away with modest quantities of excess reserves? It isn’t. While such reserves qualify as HQLAs, and, specifically, as the highest quality “Tier 1” HQLAs, so do U.S. Treasury securities, Ginnie Mae mortgage-backed securities (MBS), non-GSE agency debt, and, since October 2014, deposits at the Fed’s Term Deposit Facility. Furthermore, up to 40 percent of banks’ HQLAs may consist of “Tier 2” assets, which include other GSE securities, certain corporate bonds, and qualifying common stock. In short, banks might, in principle, meet their LCR requirements without holding any excess reserves at all. It turns out that in claiming that banks are now “required” to hold immense quantities of excess… — location: [948](kindle://book?action=open&asin=B07MWJMK1F&location=948) ^ref-4926 --- If, for example, the risk-intolerance parameter has a value of 3, a 25-basis-point reduction in the IOER rate would, all else equal, reduce excess reserves’ share of HQLAs “by about 10 percentage points,” while increasing that of Treasury securities by the same amount (ibid, p. 17). Overall, these findings suggest that IOER has contributed substantially to banks’ use of excess reserve balances to meet their LCR requirements.32 Norway’s experience, finally, in moving from a floor system to a “quota” system, where bank reserve balances held in excess of preassigned limits were compensated not at Norges Bank’s policy rate but at that rate minus 100 basis points, confirms predictions such as those just considered. Indeed, several Norwegian banks complained that the switch made it costlier to satisfy their LCR requirements by compelling them to “seek other Level 1 assets as an alternative” to deposits at Norges Bank (Norges Bank 2014, pp. 21–22). To its credit, Norges Bank replied that “enabling banks to meet regulatory requirements at the lowest possible costs is not a concern [it] takes into account in its liquidity management” (Norges Bank 2014, p. 22). — location: [968](kindle://book?action=open&asin=B07MWJMK1F&location=968) ^ref-45932 --- banks’ demand for excess reserves is driven by the yield on such reserves compared to that on other assets, then the ratio of excess reserves to total bank assets should vary with the difference between the IOER rate and comparable short-term market rates, such as the overnight LIBOR rate. A recent study by David Beckworth (2018) shows that this has indeed been the case. As Figure 7.8 shows, for U.S. banks as a whole, the two values are closely correlated, — location: [979](kindle://book?action=open&asin=B07MWJMK1F&location=979) ^ref-11013 --- Some may doubt that IOER accounts for U.S. banks’ exceptional demand for excess reserves, and the associated decline in bank lending, because similar developments have been observed elsewhere where banks’ reserve balances bore no interest. Of these cases Japan’s is perhaps the most notorious. — location: [1120](kindle://book?action=open&asin=B07MWJMK1F&location=1120) ^ref-55735 Can I OER be blamed if other countries experienced no cending but didn't have 10ER. --- While it doesn’t contradict the claim that IOER can be a crucial determinant of banks’ willingness to accumulate excess reserves, Japan’s experience does cast doubt on the suggestion that a U.S. IOER rate of zero would have sufficed after 2008 to keep banks there from hoarding excess reserves. — location: [1159](kindle://book?action=open&asin=B07MWJMK1F&location=1159) ^ref-45502 --- A shortage of bank capital, on the other hand, might have prevented banks from increasing their loans despite the presence of both abundance of excess reserves and favorable lending opportunities. As Huberto Ennis and Alexander Wolman (2011) explain, As a readily available source of funding, high levels of reserves provide flexibility to a bank that is looking to expand its loan portfolio. However, loans (and risky securities) are associated with higher capital requirements than reserves. A bank that is holding reserves but is facing a binding capital constraint is thus unlikely to engage in a sudden expansion of lending. As with deposits, raising capital quickly can be costly. For this reason, even a bank that holds a high level of excess reserves may not be able to take advantage of new lending (or investment) opportunities (p. 276). However, in their own study of this possibility, Ennis and Wolman find that while many banks were indeed capital constrained during the Fed’s “first wave of reserve increases,” by the last quarter of 2009 bank capital had recovered to the point where, of $510 billion in reserves held by the biggest 100 banks, $485 billion were loanable. — location: [1175](kindle://book?action=open&asin=B07MWJMK1F&location=1175) ^ref-46344 --- changes in BHCs’ capital ratios had only modest effects on loan growth. Instead of worrying about capital, banks and BHCs seemed more concerned about things like loan demand and risk. — location: [1185](kindle://book?action=open&asin=B07MWJMK1F&location=1185) ^ref-34272 --- According to Jim Wilkinson and Jon Christensson (2011, pp. 43, 46), who investigate lending by community banks in the Tenth Federal Reserve District between the start of 2001 and the end of 2009, programs established during the crisis for the purpose of placing funds into those banks’ capital accounts did so little to boost that lending that it would have been “more effective for policymakers to give money directly to small businesses in the form of grants or loans.” — location: [1188](kindle://book?action=open&asin=B07MWJMK1F&location=1188) ^ref-22817 --- According to Bowman et al. (2011, p. 6), despite zero rates on BOJ deposits, banks preferred accumulating balances there to increasing their interbank deposits, which yielded small but still positive returns at the time, in part because Bank for International Settlements regulations considered BOJ deposits to be riskless, whereas those regulations required that 20 percent of interbank deposits be counted as risky assets against which capital had to be held. — location: [1205](kindle://book?action=open&asin=B07MWJMK1F&location=1205) ^ref-7828 --- Fearing that its emergency lending would prevent it from keeping the fed funds rate at 2 percent, the Fed sought permission, as we’ve seen, to start paying interest on banks’ reserves to keep its emergency credit from spilling into the fed funds market. — location: [1260](kindle://book?action=open&asin=B07MWJMK1F&location=1260) ^ref-381 --- Commenting on the Fed’s action not long afterward, David Beckworth (2008) went so far as to compare the Fed’s mistake to the one it made in 1936–1937.39 Some years later Scott Sumner (2017), having the advantage of hindsight, reached a verdict that was hardly less damning. “The decision to adopt IOR,” Sumner wrote, “helped to prevent the Fed from achieving its policy goals, by making the Great Recession more severe than otherwise.” He continued, The world would be a better place today if the Fed had never instituted its policy of IOR in 2008. I really don’t see how anyone can seriously dispute this claim. If you want to dispute the claim, in what specific way did IOR make the world a better place? When the policy was adopted in 2008, the New York Fed explained it to the public as a contractionary policy. Can anyone seriously argue that the world would be worse off if monetary policy had been less contractionary in 2008–12? — location: [1263](kindle://book?action=open&asin=B07MWJMK1F&location=1263) ^ref-3761 --- Thus far, at least, the Fed’s experiment was proceeding according to plan. For despite the economy’s ongoing decline, that plan called not for loosening monetary policy but for avoiding further loosening—and the revival of spending such loosening might have inspired—by preventing growth in the Fed’s balance sheet from encouraging additional bank lending. Before the end of November 2008, however, the Fed had concluded that the economy needed to be stimulated after all. The trouble was that, with the Fed’s new floor system in place, achieving a monetary stimulus was only barely possible in theory, and lamentably difficult in practice. — location: [1279](kindle://book?action=open&asin=B07MWJMK1F&location=1279) ^ref-62674 --- They understood, furthermore, that the changes meant that Quantitative Easing, if it was to stimulate at all, could not do so by means of the usual multiplier-based monetary transmission mechanism. Some, including Bernanke himself, even went so far as to object to the expression “Quantitative Easing” because it suggested, misleadingly, that the Fed regarded LSAPs as a means for expanding the quantity of money, and for giving a boost thereby to spending, prices, and employment. — location: [1308](kindle://book?action=open&asin=B07MWJMK1F&location=1308) ^ref-29437 --- In any event, Bernanke and other Fed officials hoped that the Fed’s asset purchases might instead influence the real economy through other channels. In particular, they appealed to the existence of a “portfolio balance” channel, in which changes in nominal (dollar) values, and nominal bank lending especially, played no essential part. Instead, the Fed’s asset purchases were supposed to boost real economic activity by “reducing [credit] spreads and improving the functioning of private credit markets” (Bernanke 2009). Swapping bank reserves for long-term securities, in particular, was expected to promote investment by lowering long-term interest rates. — location: [1320](kindle://book?action=open&asin=B07MWJMK1F&location=1320) ^ref-31820 --- given the prevailing circumstances, it is difficult to see why the Fed would resist a potentially helpful IOER rate reduction just because its anticipated benefits would be “relatively small.” What, exactly, were the offsetting costs that made pursuing these small benefits unworthwhile? If there were none, why would the Fed resist a policy change that could achieve even the slightest gain? Is it possible that Fed officials were reluctant to revert to a zero IOER rate out of fear that by doing so they would appear to have regretted resorting to a positive IOER rate in the first place? — location: [1406](kindle://book?action=open&asin=B07MWJMK1F&location=1406) ^ref-45810 --- Despite Bernanke’s doubts, the possibility of lowering the IOER rate to zero remained a live one for some time. About a year after Bernanke’s Jackson Hole remarks, in response to more bleak news about the pace of the recovery, the FOMC again considered lowering the IOER rate as one of three alternatives, — location: [1420](kindle://book?action=open&asin=B07MWJMK1F&location=1420) ^ref-31046 --- the risk that a commitment to it might lead to overly tight policy in the future should be considered another shortcoming of the Fed’s postcrisis operating system. — location: [1657](kindle://book?action=open&asin=B07MWJMK1F&location=1657) ^ref-44499 --- Until it switched to a floor system, the Fed discouraged banks from holding excess reserves by confronting them with a substantial opportunity cost of doing so. The new system, in contrast, encourages banks to hold unlimited quantities of excess reserves and (what amounts to the same thing) to lend a correspondingly large part of the savings they secure from depositors to the Fed. — location: [1725](kindle://book?action=open&asin=B07MWJMK1F&location=1725) ^ref-33148 --- The Fed’s increased role in financial intermediation is reflected in the fact, illustrated in Figure 8.2, that bank reserves, which until the recent crisis made up only a fraction of a percent of total bank deposits, are now equal to a fifth of those deposits. Bank lending to businesses, farmers, and consumers, on the other hand, has gone from roughly matching total bank deposits to being equal to only four-fifths of those deposits. The Fed has thus made itself responsible not merely for regulating the nominal scale of deposit-based financial intermediation in the U.S. economy but for disposing of a substantial share of the public’s savings. — location: [1730](kindle://book?action=open&asin=B07MWJMK1F&location=1730) ^ref-44070 A gignifant amount of bank assets are cut to the fed which in turn allocates to the treasury or mortgages, --- According to the FOMC’s original guidelines concerning them, the Fed’s agency security purchases also weren’t “designed to support individual sectors of the market or to channel funds into issues of particular agencies” — location: [1757](kindle://book?action=open&asin=B07MWJMK1F&location=1757) ^ref-1751 --- Because the Fed’s own portfolio choices are limited, and especially because those limits generally exclude lending to nonfinancial firms or individuals, it can’t be expected to employ savings as efficiently or productively as commercial banks. It’s therefore only reasonable that it should be expected to intrude as little as possible on “market-directed resource allocation” and, specifically, that it should avoid having banks hold unnecessarily large balances with it. Indeed, central banks that do otherwise have long been condemned for engaging in what economists call “financial repression,” meaning practices that “prevent an economy’s financial intermediaries . . . from functioning at their full capacity,” thereby interfering with the efficient allocation of credit and impairing economic growth — location: [1760](kindle://book?action=open&asin=B07MWJMK1F&location=1760) ^ref-18131 By forcing banks to hold large reserve balanes at the fed if creates financiarep ssion. Fed can only tend to specific sectors. --- As we’ve seen, by establishing a floor system and generating trillions of dollars in additional reserve balances, the Fed has increased the share of Fed-directed resource allocation, while reducing that of market-directed resource allocation to a correspondingly great extent. Instead of being offered by private-sector lenders to (mainly) private-sector borrowers, the real resources represented by commercial banks’ excess reserve balances are channeled by the Fed toward the institutions that issued the securities it purchased during several rounds of Quantitative Easing. While it’s generally recognized that high mandatory reserve requirements are financially repressive, some may wonder whether making it worthwhile to banks to accumulate excess reserves can have similar consequences. If holding reserves pays more than other uses of funds, then isn’t it also efficient for banks to hold reserves instead of acquiring other assets? The answer is that it would be efficient if the Fed’s relatively high IOER rates reflected its own capacity to employ funds more productively than private-market lenders. In fact, the Fed’s ability to pay above-market IOER rates has been due not to its being an unusually efficient intermediary but to the seigniorage it earns on its noninterest-bearing notes and on noninterest-bearing balances kept with it, which it can use to cross-subsidize bank reserves. Furthermore, because the Fed doesn’t practice mark-to-market accounting, it doesn’t have to provide for unrealized portfolio losses. Consequently, it is able to finance relatively high IOER rates in part by assuming greater risks, including the substantial duration risk it took on by acquiring long-term Treasury and mortgage-backed securities. By using those high IOER rates to compete with private-sector borrowers for commercial bank funds, the Fed alters both the scope and the direction of bank-assisted financial intermediation. — location: [1778](kindle://book?action=open&asin=B07MWJMK1F&location=1778) ^ref-60555 --- Many reasons have been offered for the slowdown, one of which is a deficient supply of bank credit. As the abstract to a recent IMF study (Duval, Hong, and Timmer 2017) puts it, “the combination of pre-existing firm-level financial fragilities and tightening credit conditions made an important contribution to the post-crisis productivity slowdown.” San Francisco Fed economists Michael Redmond and Willem Van Zandweghe (2016, p. 41) consider a reduced postcrisis supply of credit the “primary suspect” in the postcrisis decline in U.S. total factor productivity, blaming it for having “prevented [established] firms from investing in innovations” and for making it harder for new firms to enter the market (ibid., p. 39). The tightening of credit to which the above-mentioned studies refer is likely to be due, at least in part, to crisis-related fears and uncertainties, together with more stringent postcrisis bank regulation. Some of it can also be traced to novel postcrisis central bank operating frameworks, floor systems especially, that have reduced the flow of bank credit to business borrowers by boosting banks’ demand for reserve balances. By encouraging banks to fund central bank balance sheets instead of making loans to businesses, these arrangements make it more difficult, other things being equal, for businesses to finance capital investment and R&D, both of which contribute to productivity. — location: [1823](kindle://book?action=open&asin=B07MWJMK1F&location=1823) ^ref-6051 --- Determining the approximate size of this adverse contribution is far from simple, in part because it means untangling the contribution of the Fed’s re-direction of credit from that of other, including regulatory, credit-supply “frictions.” The necessary research has yet to be undertaken. But given the Fed’s long-standing precrisis policy of maintaining a small credit footprint and the understanding of the advantages of private credit allocation upon which that policy rested, the burden of proof should surely be borne by those who maintain that the Fed’s new operating system, with the much-enlarged Fed credit footprint it entails, has not contributed, or has contributed only insignificantly, to the productivity slump.57 — location: [1838](kindle://book?action=open&asin=B07MWJMK1F&location=1838) ^ref-16362 --- common examples of financially repressive policies include “interest-rate ceilings, liquidity ratio requirements, high bank reserve requirements, capital controls, restrictions on market entry into the financial sector, credit ceilings or restrictions on directions of credit allocation, and government ownership or domination of banks.” — location: [1853](kindle://book?action=open&asin=B07MWJMK1F&location=1853) ^ref-42905 --- Silvia Merler (2018) surveys important recent research, mostly pertaining to countries other than the United States, concerning “The Financial Side of the Productivity Slowdown.” — location: [1868](kindle://book?action=open&asin=B07MWJMK1F&location=1868) ^ref-3549 --- Making the Fed’s balance sheet unrelated to monetary policy, opens the door for the Fed to use its balance sheet for other purposes. For example, the Fed would be free to engage in credit policy through the management of its assets while not impinging on monetary policy. Indeed, the Fed’s balance sheet could serve as a huge intermediary and supplier of taxpayer subsidies to selected parties through credit allocation — location: [1949](kindle://book?action=open&asin=B07MWJMK1F&location=1949) ^ref-20028 --- While inflation makes headlines, reserve hoarding doesn’t. That’s why the Brave New World of interest on reserves is so dangerous. Faced with the usual pressure to help the government pay its bills, Fed officials, and a pliant or weak Fed Chair especially, might cave-in to the government’s demands while still meeting the Fed’s inflation targets. In theory they could go on meeting the government’s demands until every penny in bank deposits is financing some government spending, leaving nothing for private-sector borrowers. — location: [1966](kindle://book?action=open&asin=B07MWJMK1F&location=1966) ^ref-42034 ---