Looks like behind the scenes they may be getting their banks to fund Greece and, by extension, any other national govt. this which will buy time, though longer term it depreciates the currency, which they may want to happen as well.

As long as the banks can carry their eurozone bonds at par and book the interest as earnings and fund themselves based on implied govt guarantees there is no operational limit to how long they can continue.

The limits would be the extent to which the banking laws restrict this practice, and the political tolerance for any inflation that may get imported through the fx window should the euro continue to fall.

The other problem is the downward pressure on aggregate demand of the prerequisite ‘fiscal consolidation’ is likely to result in increased social unrest as living conditions further deteriorate.

And this could be accelerated if the fiscal consolidation were to include reductions of transfer payments.

33 Responses

  1. Rebecca Wilder, The end game for Europe: wage cutting and the battle for exports

    Wilder concludes, “And what happens when export income does not provide the impetus for aggregate demand growth? Well, there’s not much left. Can’t devalue the currency (via printing money), and tax revenues will fall faster than a ten-pound weight: rising deficits; rising debt; rising debt service (via surging credit spreads). Sovereign default seems like a near-certainty somewhere in the Eurozone!”

    1. Krugman piles on with Wilder:

      “It’s the euro version of Andrew Mellon: liquidate Lativa, liquidate Greece, liquidate Spain, purge the rottenness ….” [paraphrasing Treasury Sec. Andrew Mellon to Herbert Hoover]

      Competitive Deflation

    2. Anyone understand what is going on in Iceland? Heard this morning that taxes are being increased to cover deposit insurance breakdowns for external depositors to “ICE Save”. I could not believe what I was hearing. Sounds they are being extorted for non-sovereign debt issue and if they default the
      IMF, and EU will turn them down. Why does a sovereign issuer of currency need the IMF anyway?

      1. JC “extortion” seems like a good choice of words, the report I read said the citizens voted 93% against it, and yet a Iceland govt officical termed the vote “obsolete” already, as it looks like the Iceland govt is negotiating a new deal with uninsured Inclandic bank depositors in the UK and Netherlands. this is similar IMO to what Warren has been warning about over there as to the effect that there is no credible deposit insurance the way they have things set up.

      2. From what I have read, it seems like there are treaty obligations for governments to provide deposit insurance for their banks’ foreign branches, up to 20,000 euros. British and other governments paid their depositors more than that, and the question is now what Iceland owes them, and when and how it will be paid. It is not a simple question. 🙁

  2. This sounds as if there really is not a “European Central Bank”? At least it seems as a “lender of last resort”.
    EU Works on IMF-Style Lender
    “March 8 (Bloomberg) — European leaders are in talks to establish a lender of last resort…..Offer confirmed plans by Schaeuble, made in an interview with the Welt am Sonntag newspaper yesterday, for a euro-region institution similar to the International Monetary Fund to avoid another Greek crisis.”

    Related Greek Prime Minister to speak at Brookings this 1030 AM, CSPAN2 supposed to simulcast here., Resp

  3. March 8, 2010

    The Federal Reserve Bank of New York today announced the beginning of a program to expand its counterparties for conducting reverse repurchase agreement transactions (“reverse repos”). This expansion is intended to enhance the capacity of such operations to drain reserves beyond what could likely be conducted through the New York Fed’s traditional counterparties, the Primary Dealers. This announcement is pursuant to the October 19, 2009, Statement Regarding Reverse Repurchase Agreements, which announced that the New York Fed was studying the possibility of expanding its counterparties for these operations. The additional counterparties will not be eligible to participate in transactions conducted by the New York Fed other than reverse repos. This expansion of counterparties for the reverse repo program is a matter of prudent advance planning, and no inference should be drawn about the timing of any prospective monetary policy operation.


    1. JKH,
      there are 19Primary Dealers now, they are down to only 7 that one would consider “US based” or “US owned”…do you think this makes them nervous in that if they felt the Fed really needed to unload some securities …(right of wrong i know)… that some in their current “lineup” would perhaps leave them hanging?

    2. Interesting question, Matt.

      It seems parallel to the question of what happens if China “dumps” treasuries:

      First, they’d be foolish to do so. Second, they’d be doubly foolish if they’re not also dumping dollars, which is foolish in itself. Third, if they’re dumping dollars, somebody else outside the US still has to buy them, and they’d probably want to buy liquid treasuries as a result.

      So long as the US continues to issue treasuries, it’s in everybody’s interests to continue to have deep global distribution capability. That’s a demand argument for foreign based dealers. The supply argument is that the foreign dealers are just as greedy to make money from dealing in treasuries.

    3. NY Feds Sack followed up with this speech today, (if you didnt see this ;). 101% for the benefit of the inflationistas IMO.

    4. Matt, I thought the speech was fairly good in a few ways:

      “However, even as the pace of our purchases has slowed, longer-term interest rates have remained low, and MBS spreads over Treasury yields have remained tight. This pattern suggests that the effects of the purchases have been primarily associated with the stock of the Fed’s holdings rather than with the flow of its purchases. In that case, the market effects of the purchase program will only slowly unwind as the balance sheet shrinks gradually over time.”

      A lot of people that should get this, don’t get it (e.g. Gross from Pimco).

      “With this approach, the FOMC would be shrinking its balance sheet in a gradual and passive manner. That, in my view, is a crucial message for the markets.”

      Seems obvious, as opposed to worrying about what the worry warts are worrying about (aggressive selling).

      “policymakers do not need to use this tool to tighten financial conditions. They can tighten financial conditions as much as needed by raising short-term interest rates, offsetting any lingering portfolio balance effects arising from the still-elevated portfolio.”

      Again, obvious and correct, as opposed to the fear mongering about the size of the balance sheet.

      “Even under this cautious strategy of relying only on redemptions, the Federal Reserve could achieve a considerable decline in the size of its balance sheet over time.”

      Reasonable again.

      “We would expect changes in the interest rate on reserves to have a significant influence on other short-term interest rates. However …”

      The reverses and term deposits are just insurance for the level of interest rate control precision.

      “Removing a portion of the excess reserves from the system ahead of increasing the rate paid on reserves is a cautious approach, as it should improve the Fed’s control of short-term interest rates when it comes time to tighten monetary policy.”

      Notice again it’s about interest rate control. To his credit, he says nothing in this speech about banks “lending reserves”. And as well in the final footnote:

      “Some have discussed whether the draining of excess reserves has effects on the economy beyond the implications for short-term interest rates. In my view, it would be surprising if there were significant effects on the real economy or inflation associated with substituting one short-term, liquid, risk-free asset (reverse repos or term deposits with the Fed) for another (reserves), except for the degree to which that substitution affects the Fed’s control of overnight interest rates.”

      Interest rate control again; not “lending reserves”. Not bad overall. It’s the market that’s got a lot of this stuff wrong, rather than the Fed, at least in this case.

      1. “However, in order to ensure our ability to influence those other short-term interest rates, we have been developing two tools that can be used to reduce the large amount of excess reserves in the banking system—term deposits with banks and reverse repurchase agreements (reverse repos) with a broader universe of financial institutions. Let me first provide an update on the progress we have made in developing these tools.”

        Shows good understanding – the Fed doesn’t just want to target overnight balances – it also wants to have a transmission. In normal circumstances, the transmission is easier. With such high reserve balances, banks may not increase the lending rates proportional to increases in the Fed Funds target. So in normal circumstances, it is about the price and not the quantity, in these times, even though it is true for the fed funds rate (P not Q), it may not be true for other rates.

        e.g., a bank may exchange clearing balances for 1y term deposits but because of this, its “profits” in the next quarter will be lesser than otherwise, because there is less of interest income and hence will increase lending rates. Reverse RP will also take away income that banks would have earned otherwise.

      2. Oops I meant …the Fed doesn’t just want to target the Fed Funds rate … in the second para instead of “the Fed doesn’t just want to target overnight balances”

      3. “In normal circumstances, the transmission is easier. With such high reserve balances, banks may not increase the lending rates proportional to increases in the Fed Funds target.”

        hmm… I’m not sure I’m understanding your meaning here Ramanan. You seem to be saying that the size of reserve balances affects the price of risk. That’s an interesting idea, but I’m not sure how it works, so I’m doubtful.

        Also, you seem to be saying that bank interest margins will decline if they switch from ON priced reserves to term deposits. That depends on asset liability term matching strategies and/or the subsequent path of fed funds.

      4. Will come back on that. Not assuming changes in the price of risk. Its sort of inverse of the cost of funds argument.

  4. Hmm, nothing to do with P or Q, but I would Google “Bank Core Deposits and the Mitigation of Monetary Policy”.

    “The only banks that are likely to raise loan rates substantially in response to an increase in the federal funds rate are banks with a high proportion of relationship loans that are close to a loan-to-core deposit ratio of one[…]
    Importantly, these banks hold only a small fraction of U.S. banking assets. Thus, in the United States, the bank lending channel seems limited in scope and importance.”

    1. Yes .. didn’t claim that – in fact the reverse 🙂 Always good to get the Ps and Qs right.

      Refer you to Monetary Economics Wynne Godley & Marc Lavoie pages 400-404.

  5. R,

    I don’t have G/L, but the only purpose for paying interest on reserves is to increase either short term or long term lending rates, and the paper I cited has some robust statistical data that banks’ marginal costs are unchanged as a result of an increase in the marginal cost of reserves.

    Therefore trying to increase the marginal cost of reserves is unlikely to cause either short-term or long term rates to move.

    The hypothesized channel for a rate hike is called the “Balance Sheet Channel”:

    OMO –> MM rates –> balance sheet deterioration on the part of borrowers –> higher rates charged to borrowers

    And FF also happens to move as a result of the hike in MM rates, but the move in FF is not the cause of the move in rates. I.e. causality runs from MM rates to FF and from MM rates to long term lending rates.

    Therefore tweaking with the marginal costs of reserves directly will not have an effect. You need to directly hit the short term funding markets via an OMO in order to raise either short or long term rates.

    Of course, this has never been tried before, but the empirical and theoretical basis for the statement “We would expect changes in the interest rate on reserves to have a significant influence on other short-term interest rates. ” is weak.

    1. the Bank of Canada is able to achieve the target quite accurately. MM rates do not matter.


      The Fed is also going to implement a corridor system (thinking of) just like in Canada

      Of course, I am with you about factor affecting lending rates and other money market rates! not exactly on the causalities though – and a lot of this is country specific. That is how the CP market developed – with the realization that it offers cheaper alternatives to borrowing directly from banks. And banks have become different from the banks one thinks of. Again, country specific.

      The article Matt referred to (the speech) talks of reverse repos as well – having Money Market Mutual Funds as counterparties. How good it is in transmission is difficult to guess but what I meant was that it is thinking of influencing short term rates by these means in these times. In normal times with lesser settlement balances, the Fed is able to influence short term rates like T-bills and hence the CP market. I normal times, I wouldn’t believe that the MM market has an influence on T-bills. Fidelity MMMFs used to do lend big time to broker-dealers in the repo market at FF+2/3bps. (3 yrs back or so – havent checked lately)

      As far as the influence on the economy is concerned, PKEists will say that it has no or little effect on demand because the fiscal channel is much more powerful and I believe that.

  6. I’m not saying that a CB can’t achieve a target marginal cost of reserves — clearly it can!

    The question is, will paying interest on reserves succeed in increasing short term MM rates or (bank) lending rates? If it does not, then it cannot affect the economy and there is no reason to do it, particularly as it increases bank income and is therefore evil.

    In that case, we should stop paying interest on reserves, and take this off the table — but right now it is on the table and is cited as a method the CB can use to tighten.

    In terms of MM rates being irrelevant, the counterparty to an OMO is a participant in the short term funding markets and banks tap this market as part of their liabilities management policy prior to borrowing reserves from each other — at least that is my impression someone else here can verify. I agree that this is country specific — there are many other ways of controlling interbank lending rates. You could do operations purely between the CB and the interbank lending market, and then rely on the bank intervention in the MM to move the MM rates. You could just force the banks to hold all short term liabilities only with the government and then just declare what banks’ marginal costs are without paying them anything, etc.

    As far as effect on the economy, let’s see if a Volcker-style rate hike 20% would affect the economy or not:)

      1. There would be too much collateral damage from non-financial businesses that need to roll over CP

      2. Yeah, but boy would it boost income to savers. I’m just curious to see if the fiscal effect is large enough to get AD back up. If have customers in the door, you aren’t as reliant on revolving CP.

      3. No, it wouldn’t boost incomes in aggregate — that is a fallacy of composition.

        Higher interest rates do not increase the incomes of asset holders — every interest payment is a benefit to the note holder but a cost to someone else that would want to sell the borrower a product, so the asset holders of those companies get fewer dividends, and the note holders get more. In a diversified portfolio it washes out.

        In aggregate, it is the amount borrowed that determines the increase in financial assets — i.e. change in liabilities = change in assets — not the terms of repayment.

        The latter enters into the picture only to the degree that it encourages or discourages more aggregate borrowing, and a spike in rates would decrease aggregate debt growth, and therefore decrease the growth of assets.

  7. Matt Franko,

    Just when we found a New York fed guy who understands some important things, we’ve got a Chicago fed man who’s clueless:

    “Finally, we must also keep in mind that more monetary stimulus also has costs. These could be considerable at higher LSAP levels. Many are already worried about the inflation implications of the Fed’s expanded balance sheet and the associated large increase in the monetary base. Currently, most of the increase in the monetary base is sitting idly in bank reserves—and because banks are not lending those reserves, they are not generating spending pressure. But leaving the current highly accommodative monetary policy in place for too long would eventually fuel inflationary pressures. Likewise, if the monetary base was expanded much beyond where we are today, the risk that such pressures would build as the economy recovers would be significantly increased. Furthermore, policymakers already face the task of unwinding a sizable balance sheet at the appropriate time and pace. Substantially increasing the size of asset purchases could have further complicated the exit process down the road.”


    1. Minneapolis may not be in any better shape: “It is reasonable to suppose that banks have been willing to hold such a large volume of assets at the Fed because short-term interest rates offered by the market have declined to essentially zero, while the Fed has been paying interest at an annualized rate of 25 basis points (0.25 percent) on balances held at the Fed….If banks draw down their excess reserves too quickly as they seek to use these funds for alternative purposes (such as making personal loans or business investments), the economy will be flooded with more liquidity than it may be able to handle…”

      I just wish that they would at least also acknowledge that they are willing to continue with the Credit Easing as a legitimate alternative policy if deflation starts up again after they take their break at the end of this month. No one in the System seems to want to even mention this….Resp,

      1. Isn’t Minneapolis the ground zero of RBC? Looking at the research papers coming out of the Minneapolis Fed compared to say the SF Fed, I always thought that they were more acutely cognitively captured by the freshwater schools.

  8. Ramanan,

    No wonder he knows how it works; he actually does a real job at the Fed – the system open market account. Interesting career path. He’ll put out some interesting papers down the road. Every economist should spend some time on a money desk, but virtually none do.

    BTW, I disagree with virtually everything said above regarding the influence of the funds rate and reserve interest on other rates. But I’ll leave it at that for now. I’ve spent enough time arguing how banks work with delusional monetarists, and don’t want to extend that here among more informed company.

    I would be interested however, if you or anybody have any thoughts on the accounting entries for the $ 1 trillion Euro drop, per:


  9. the ecb credits member bank accounts

    the ecb debits its accounts payable to the european parliament, or whatever they call that account where they turn over profits every year to the ep. no problem with that account going negative. they can still turn over anything they want to.

Leave a Reply to JKH Cancel reply

Your email address will not be published. Required fields are marked *