Dudley, a former Goldman Sachs economist, also rejected the widely held view that the Fed is really printing money. “What we’re doing is, when we buy Treasury securities, we are increasing the amount of reserves in the banking system.


For those reserves to actually create money, the banks actually have to lend those reserves out.


The problem with the U.S. economy now is that there is insufficient lending and he doesn’t expect the Fed’s purchase program to solve that problem because there are ample reserves in the system. He expects the current program to help the economy by lowering interest rates for businesses and consumers.

Ok, he mostly gets it. Like when one of the slow kids in class gets something close enough to right and gets a passing grade.

(If anyone reading this knows him personally, try sending him a copy of my book, thanks)

14 Responses

  1. Painful to think he actually managed the SOMA before become president, yet still writes about banks lending reserves out. He should have had a PHD in reserves by now, not just a passing grade in 101.

  2. Warren, you must know people who are on the actual trading desk of the Fed – do they know the score? Are they like most of us out in the trenches of Corporate America, who roll our eyes at the cluelessness of our “superiors”?

  3. Mr. Mosler:

    In your opinion, are these statements just designed for public consumption, or do you think they really believe this?

    Sometimes I think that they use language such as “… the banks actually have to lend those reserves out.” as a shortcut, thinking the inaccuracy is not important in the context of making a public statement.

    Or maybe they really don’t know how their institution operate? It can’t be such a leap for bankers to know that banks will lend to worthy borrowers – isn’t that banking 101? Also that reserves can be purchased after the fact?

    And even if the senior management of these institutions don’t get it (or are simply sloppy), there must be mid-management who sees what is going on?

    My question being – does the Fed (as an institution) really think that excess reserves are needed to stimulate borrowing? I prefer to think that there must be some other role the excess reserves play, otherwise this whole QE2 is a kind of Kabuki theatrical head fake.

    My understanding is that the only structural reasons for excess reserves is interest rate maintenance and liquidity provision. Of course there are market psychology impacts. But is there anything else we could be missing? Might there be a liquidity crisis on the horizon?

    Does the potential lowering of long-term interest rate bolster bank balance sheets (I assume they have loads of high-coupon junk assets sitting around)? Is this effect significant?

    1. He spent 10 years working with Jan Hatzius, he knows the score.
      I think Dudley said “lend out reserves” because after making the crucial point that increasing reserves is not inflationary, it would just muddy the waters to further explain to the public how the banking system actually operates.

      People can only absorb so much new information at once. The day a mother explain to a child where babies come from is not the right time to also explain he was kidnapped from his real mommy in a mall parking lot, too much new information.

    2. best i can tell they really do believe what they say.

      and they don’t understand actual monetary operations.

      yes, most of the mid management people in fed monetary operations get it right.

      many of the fomc think there is a channel from reserves to bank lending.

      and seems to me lowering long term rates doesn’t have the desired macro effect of increasing aggregate demand.

      pretty sad state of affairs

  4. “He expects the current program to help the economy by lowering interest rates for businesses and consumers.” Yes, I’m sure all those underwater “consumers” are just itching to run out, borrow yet more and get themselves even further underwater.

    As for “lowering interest rates for …businesses”, there is a surplus of capital equipment lying idle in the current recession, as is normal in recessions. That being the case, and given that businesses normally borrow to fund capital equipment purchases, encouraging such borrowing is near pointless.

    Businesses just need extra demand. Whether they meet the demand with extra labour or extra equipment is a decision they can make for themselves without any assistance from politicians or central bank officials, most of whom couldn’t run a convenience store.

  5. Warren,
    I think I recall you saying banks are insolvent on the way up. With the Fed holding short term rates low for a long period, how does this play out if/when the Fed decides to raise the FFR? Is the Fed limited in raising rates for fear of causing a bank crisis?

    1. Why does it ever have to raise the FFR? It could slow down the economy just as easily by widening the prime rate spread (on condition, I suppose, that banks don’t undercut the rate with favored customers by using LIBOR rates). As Steve Randy Waldman pointed out, the spread between FFR and Prime Rate varied but averaged 1.33% prior to 1991, since then its been a steady 3.0%.

      If the goal is to use interest rates to slow down the economy without decreasing bank profitability (or increasing Tsy net interest costs), just increase the prime rate spread. I suppose you could cut it back to 1.33% but there are easier ways to drive every bank into insolvency, if that’s your goal. :o)

Leave a Reply

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