Home › Forums › Discuss Austrian Economics, Step by Step › Interest on Reserves
- This topic has 3 replies, 2 voices, and was last updated 6 years, 6 months ago by kallanwelsh.
October 23, 2016 at 11:56 am #18821
1) Why is the Bank of Japan potentially embarking on a “reverse Operation Twist” to steepen the yield curve? I have heard it is to help stabilize Japanese banks, but how would it? The Federal Reserve, which has been relatively less stimulative than the BOJ, did the opposite, and flattened the yield curve by buying longer term bonds. What is the reasoning behind this wonky policy?
2) Why did the Federal Reserve start paying interest on reserve balances in October of 2008, when they were doing everything they could to “stimulate”? Before then they paid an effective rate of 0%, so the Fed RAISED interest rates on reserve balances as the GDP was contracting. Doesn’t this encourage banks to keep excess reserves relative to loaning the funds out?
The only explanation I came up with is one I put my tin foil hat on for; that they started paying interest on reserves so they would have the excuse to start charging should they need another policy tool to stimulate down the road. What is the official explanation for beginning to pay interest on reserves in 2008, and what do you believe?
Thanks!November 9, 2016 at 9:02 pm #18822
Bump?November 11, 2016 at 1:13 pm #18823jmherbenerParticipant
(1) Here is a story that claims the BOJ has realized that pushing interest rates down across the yield curve has removed the incentive for banks to lend long-term. As a result, less spending on capital capacity takes place and aggregate demand slumps. The story has a Keynesian bias, but makes a valid point about the supply of credit.
(2) The Fed desires to control the broader money stock and credit supply in society, but it only directly controls the monetary base. The monetary base = currency + bank reserves. The banks have discretion in issuing fiduciary media (i.e., checking account balances) on top of their reserves. Bank checking accounts, as money substitutes, are part of the money supply. In normal times banks tend to stay fully loaned out, carrying almost no excess reserves. They do so because they earn interest on their loans and do not feel the need for liquidity beyond their required reserves. In such times, the Fed can control the money supply fairly well. But when the financial crisis hit, the Fed bailed out banks with QE1 and QE2, buying their MBS and paying with reserves. The banks desired liquidity and given the collapse of demand for credit and consequent low interest rates and heightened uncertainty of the investment climate, they built up their excess reserves to levels not seen since the Great Depression. In such times, banks can increase the money supply independently of Fed policy by issuing more fiduciary media via new loans to customers. Doing so will reduce their excess reserves, but they can continue to expand until they are fully loaned up again. The Fed instituted payment on reserves to manage that process. The Fed has one rate it pays on required reserves and another rate it pays on excess reserves. So, if banks are issuing too much fiduciary media and converting their excess reserves into required reserves too vigorously, then the Fed can raise the rate it pays on excess reserves to entice banks to slow down the conversion.
Here is the official Fed release on interest payments on reserves.
https://www.federalreserve.gov/monetarypolicy/reqresbalances.htmNovember 13, 2016 at 4:41 pm #18824
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