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Agreed. And as I’ve been saying since day one. The transmission mechanism he references isn’t broken. It never existed.

The reason banks are ‘hoarding cash’ is that the Fed has exchanged reserve balances for securities it bought in the market place.

The Fed determines reserves/’hoarding’ and not the banks.

From Dave Rosenberg: Look at the charts below and you will see how little effect the policy stimulus is exerting leaving the government continuing with demand-growth policies, such as extended and expanded housing tax credits, and the Fed, Treasury and the FHA doing all it can to keep the credit taps open … and for marginal borrowers at that. So the charts below show what, exactly? That the transmission mechanism from monetary policy to the financial system and the broad economy is still broken fully 2½ years after the first Fed rate cut. Cash on bank balance sheets as a share of total assets is at a three-decade high.

Bank lending to households and businesses has contracted more than 7% from a year ago, an unheard-of rate of decline unless you want to go back to Japan in the 90s or the U.S.A. in the 30s.

UE Rate->FF Rate”>

UE Rate->FF Rate”>


7 Responses

  1. Since there is an opportunity cost for banks in holding excess reserves in that they could be converted to another asset class paying higher interest, it seems that either the banks are holding onto reserves because they desire increased liquidity in still unsettled times, or else they think that interest rates are going to rise and don’t want to be holding tsy’s that decline in price as rates rise, since that would be an obvious loser for them.

  2. Tom H.,

    Here’s my response to a similar point at KC, that hasn’t been posted there yet:

    Yes, excess reserves have liquidity value, since they represent actual settlement balances in real time. They are as good as if not better than treasury bills as liquidity in that sense – i.e. access to settlement balances. The Fed has forced a minimum level of this dense liquidity on the system by creating these reserves as a by-product of its asset initiatives. But the system is not necessarily voluntarily demanding this level as liquidity. Individual banks can voluntarily influence their reserve share through asset liability initiatives. But they can only change the system distribution of reserves, not the aggregate level, so long as they deal with counterparties other than the central bank. And for their actions to be rational, other assets must offer superior risk adjusted returns. That availability is limited in an environment of such massive liquidity, due to pricing arbitrage already achieved. E.g. 90 day treasury bills may offer not much more or sometimes even less than reserve interest due to institutional demand. Assets further out the risk spectrum must offer yield compensation – e.g. yield for more interest rate risk on a 10 year treasury; for more credit risk on a corporate loan. And capital is required to support any kind of risk addition. When dealing with non-Fed counterparties, choices by an individual bank will only bump the distribution of reserves around the system, not change the total level in the system. It’s zero sum in that sense. With the exception of about $ 100 billion in system borrowing, only the Fed itself can act to drain the $ 1.1 trillion in total excess reserves.

  3. JKH, Scott, thanks for the clarification. I get that, but what about when things change. For example, Bill Gross is figuring that the Fed’s withdrawal from MBS purchasing in the coming year will be “disinflationary” and he says he is going to cash (unless he is talking his book), with the Fed is expected to keep the FFR low. So there is no inflationary pressure at the moment, and there’s no incentive not to hold reserves, cash. or bills.However, presumably this will begin to change at some point. Then, the Fed has to start raising rates and act to withdraw liquidity, or inflationary expectations will mount. But won’t the banks also want to start assuming more risk at that time and naturally gravitate away from excess reserves to better opportunities that are developing? Or will this not happen quickly enough to suit the Fed?

    Also, how is the Fed going to soak up the excess liquidity if they plan to hold to maturity the MBS they’ve been buying and need to drain about 1T, considering that OMO will only account for about 100B of that 1.1T?


    1. The Fed doesn’t need to drain reserves in order to tighten. It can increase the Fed funds rate along with the interest rate paid on reserves, without draining all or even part of the excess reserve position. In terms of a combination of reserve drains and interest rate increases, it can do either or both, separately or jointly, at its chosen pace for each.

      In other words, the Fed can tighten generally through higher rates, while still maintaining a specific MBS portfolio in whole or part as well as an associated excess reserve position, if it so chooses.

      In terms of combinations of reserve drain timing and rate increase timing, all options are open at this point. This is very clear – the vigorous debate about the options is evident in the FOMC minutes. Knowing those options, they’re playing it by ear at this stage, and well they should in my view. The market should take a valium for now (fat chance) and/or read a book on MMT.

      Banks don’t need reserves to increase risk assets. They only need required capital and credit worthy customers. Therefore they don’t need to get rid of reserves collectively before increasing risk assets.

      ($ 100 million didn’t refer to OMO; rather to Fed loans to banks that banks could repay when able.)

      1. Thanks, JKH, as you know this is pretty nuanced and people like me that new to this are kind of at sea with all the in’s and out’s of national accounts and banking. Really appreciate your patience and understanding.

  4. Yes, fed could hike, it’s just a vote by the fomc

    but hard to see that when both their dual mandates are saying not to do that. unemployment is way above any notion of full employment, and core inflation measures continue to threaten on the downside, as expressed at the last meeting’s minutes.

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