In this post and prior posts I’ve seen a repeated conflation of money and reserves. I’m wondering why you often write about them as if they are the same?
Whereas “reserves” are an asset of the banking system (narrowly defined as banks with a federal reserve account), “money” is representative of the short term liabilities of the financial sector (broadly defined). In this view they are distinct concepts.
If banks could park excess deposits with the FED and earn interest, why did so many banks pile into bonds when interest rates were low and now have unrealized losses on those bonds?
A combination of my anti-Fed bias and intellectual weakness made me think the article was going to have a surprise twist at the end. I'm both disappointed and humbled!
The blog post praises the Federal Reserve's use of interest on reserves and maintaining ample reserves, contrary to common criticism. The author supports the idea of paying banks interest on reserves, highlighting its benefits for controlling interest rates and ensuring financial stability. The post addresses objections, such as concerns about reduced lending by banks, arguing that ample reserves do not hinder lending. The author also explores the issue of inflation control and defends the effectiveness of the current system. Additionally, the post speculates on the reasons behind the Fed's interest rate changes not causing a recession and discusses potential improvements in the Fed's approach. Despite acknowledging imperfections, the post concludes by commending the Federal Reserve for its overall performance.
When I read your article on WSJ.com they linked me to a column by one of their in house gurus, which expressed a more negative view of the Fed's management of its balance sheet. Although it is directed to the Fed's lack of communication about it:
"The Federal Reserve Has an $8 Trillion Secret: The balance sheet is one of the Fed’s most potent tools, but officials won’t say how they plan to use it." By Joseph C. Sternberg • Dec. 7, 2023
The Fed’s decision to expand its asset holdings after 2008 (and the accompanying liabilities it has created) exerts enormous influence over the economy. ...
Quantitative easing—the expansion of the central bank’s balance sheet via the Fed’s purchase of securities worth trillions of dollars in three rounds between 2008 and 2022—is one of the most controversial things the Fed has done since the 2008 financial panic. Quantitative tightening—the gradual process of allowing those securities to run off the balance sheet as they mature—has been a central plank of the Fed’s strategy for fighting inflation since spring 2022. ...
On the liability side of the balance sheet, the Fed has abandoned the pre-2008 system in which banks’ deposits of reserves at the central bank were modest and the trading of those reserves among banks served as an important market signal (and policy tool for the Fed). ...
This is inseparable from quantitative easing. When the Fed bought assets, it increased banks’ reserve balances in exchange. So an expectation that banks will maintain permanently higher reserve balances implies a limit to quantitative tightening in the future. Yet the Fed struggles to estimate what the “correct” level of bank reserves may be. Officials miss an opportunity to solicit market feedback when they leave this out of the quarterly projections.
Unresolved questions hang over the asset side of the balance sheet as well. The most important: What does the Fed now believe is the appropriate mix of Treasury bonds and other assets, such as mortgage-backed securities, for its portfolio? ...
The answer to that question could have a big impact on the economy. Witness how the Fed’s needless purchases of mortgage securities during the pandemic created a credit subsidy that fueled a house-price boom that’s still filtering through inflation data. ...
Why does the central bank leave balance-sheet projections out of its quarterly communications if they’re so important? The embarrassing answer is that the Fed doesn’t really understand how its balance sheet works as a policy lever. ...
If they don’t think they know the answers to those questions, why did they run up the Fed’s balance sheet in the first place?
Yes, lots of theoretical benefits but where do you discuss the costs? This policy has been an unmitigated disaster for small savers. Banks used to compete with each other for reserves by offering competitive interest rates on deposits. With the system awash in reserves, no such competition takes place and so depositors are left with crumbs of 0.1% interest even as the banks earn 5% or more on their reserves. And creating a simple bank that passes such interest along to depositors is illegal!! And to claim the system is more stable today is just a re-write of banking history. Yes, IOR is a great policy if you are a connected insider but fails for the little guy. Thanks for looking out for the insiders. They definitely need the boost. :(
A grammatical quibble (from a non-economist)... The second paragraph begins "This post advertises is a Wall Street Journal OpEd, in praise of ..." I would delete the "is" if I were editor. Of course, it all depends on what "is" is.
If inflation was caused by “massive fiscal stimulus” why did auto sales decrease from around 17 million in 2019 to 15 million post pandemic while the average price of new vehicle sales significantly increased post pandemic?? That seems a supply chain issue because we clearly have the capacity to manufacture 17 million vehicles. And inventory data also points to supply issues. Did a $2000 check make Americans buy a $60k vehicle and $400k home??
You made the big time today- a takedown in the WSJ opinion section from our favorite populist senator, Rick Scott. Unburderned by facts or knowledge, he gleely panders to his constituency in the hopes they take him seriously as the Donald's successor in 2028. I consider that a notch in your belt!
Long time, first time.
In this post and prior posts I’ve seen a repeated conflation of money and reserves. I’m wondering why you often write about them as if they are the same?
Whereas “reserves” are an asset of the banking system (narrowly defined as banks with a federal reserve account), “money” is representative of the short term liabilities of the financial sector (broadly defined). In this view they are distinct concepts.
If banks could park excess deposits with the FED and earn interest, why did so many banks pile into bonds when interest rates were low and now have unrealized losses on those bonds?
Gotta love it when sterilization actually works.
A combination of my anti-Fed bias and intellectual weakness made me think the article was going to have a surprise twist at the end. I'm both disappointed and humbled!
From ChatGPT:
The blog post praises the Federal Reserve's use of interest on reserves and maintaining ample reserves, contrary to common criticism. The author supports the idea of paying banks interest on reserves, highlighting its benefits for controlling interest rates and ensuring financial stability. The post addresses objections, such as concerns about reduced lending by banks, arguing that ample reserves do not hinder lending. The author also explores the issue of inflation control and defends the effectiveness of the current system. Additionally, the post speculates on the reasons behind the Fed's interest rate changes not causing a recession and discusses potential improvements in the Fed's approach. Despite acknowledging imperfections, the post concludes by commending the Federal Reserve for its overall performance.
When I read your article on WSJ.com they linked me to a column by one of their in house gurus, which expressed a more negative view of the Fed's management of its balance sheet. Although it is directed to the Fed's lack of communication about it:
"The Federal Reserve Has an $8 Trillion Secret: The balance sheet is one of the Fed’s most potent tools, but officials won’t say how they plan to use it." By Joseph C. Sternberg • Dec. 7, 2023
The Fed’s decision to expand its asset holdings after 2008 (and the accompanying liabilities it has created) exerts enormous influence over the economy. ...
Quantitative easing—the expansion of the central bank’s balance sheet via the Fed’s purchase of securities worth trillions of dollars in three rounds between 2008 and 2022—is one of the most controversial things the Fed has done since the 2008 financial panic. Quantitative tightening—the gradual process of allowing those securities to run off the balance sheet as they mature—has been a central plank of the Fed’s strategy for fighting inflation since spring 2022. ...
On the liability side of the balance sheet, the Fed has abandoned the pre-2008 system in which banks’ deposits of reserves at the central bank were modest and the trading of those reserves among banks served as an important market signal (and policy tool for the Fed). ...
This is inseparable from quantitative easing. When the Fed bought assets, it increased banks’ reserve balances in exchange. So an expectation that banks will maintain permanently higher reserve balances implies a limit to quantitative tightening in the future. Yet the Fed struggles to estimate what the “correct” level of bank reserves may be. Officials miss an opportunity to solicit market feedback when they leave this out of the quarterly projections.
Unresolved questions hang over the asset side of the balance sheet as well. The most important: What does the Fed now believe is the appropriate mix of Treasury bonds and other assets, such as mortgage-backed securities, for its portfolio? ...
The answer to that question could have a big impact on the economy. Witness how the Fed’s needless purchases of mortgage securities during the pandemic created a credit subsidy that fueled a house-price boom that’s still filtering through inflation data. ...
Why does the central bank leave balance-sheet projections out of its quarterly communications if they’re so important? The embarrassing answer is that the Fed doesn’t really understand how its balance sheet works as a policy lever. ...
If they don’t think they know the answers to those questions, why did they run up the Fed’s balance sheet in the first place?
You must have lost your mind. High real rates of interest have an economic multiplier.
Yes, lots of theoretical benefits but where do you discuss the costs? This policy has been an unmitigated disaster for small savers. Banks used to compete with each other for reserves by offering competitive interest rates on deposits. With the system awash in reserves, no such competition takes place and so depositors are left with crumbs of 0.1% interest even as the banks earn 5% or more on their reserves. And creating a simple bank that passes such interest along to depositors is illegal!! And to claim the system is more stable today is just a re-write of banking history. Yes, IOR is a great policy if you are a connected insider but fails for the little guy. Thanks for looking out for the insiders. They definitely need the boost. :(
A grammatical quibble (from a non-economist)... The second paragraph begins "This post advertises is a Wall Street Journal OpEd, in praise of ..." I would delete the "is" if I were editor. Of course, it all depends on what "is" is.
If inflation was caused by “massive fiscal stimulus” why did auto sales decrease from around 17 million in 2019 to 15 million post pandemic while the average price of new vehicle sales significantly increased post pandemic?? That seems a supply chain issue because we clearly have the capacity to manufacture 17 million vehicles. And inventory data also points to supply issues. Did a $2000 check make Americans buy a $60k vehicle and $400k home??
You made the big time today- a takedown in the WSJ opinion section from our favorite populist senator, Rick Scott. Unburderned by facts or knowledge, he gleely panders to his constituency in the hopes they take him seriously as the Donald's successor in 2028. I consider that a notch in your belt!
How can ‘massive fiscal stimulus’ be the cause of inflation if no new money is created? I thought the Fed monetized the Covid borrowing?