...some people wonder if lowering this rate would lead banks to hold smaller deposits at the Fed and instead lend out some of these “idle” balances. In this post, we use the structure of the Fed’s balance sheet to illustrate why lowering the interest rate paid on reserve balances to zero would have no meaningful effect on the quantity of balances that banks hold on deposit at the Fed.Yikes, as I will explain below, this shows totally confusion about reserves, and these are Fed economists.
Since 2008, the amount of money banks hold on deposit at the Federal Reserve has increased dramatically, as shown in the chart below. The vast majority of these funds represent excess reserves, that is, funds held above the level needed to meet an institution’s reserve requirement.
Here's where they get confused:
Some observers have called for the Fed to lower the interest rate it pays on excess reserves (often called the IOER rate) as a way of encouraging banks to maintain lower balances.They have here switched their point of focus. The lower balances they should be referring to are excess reserves and in relation to required reserves--not "balances" (reserves in total).
What would occur if the Fed significantly lowered the rate paid on excess reserves? Banks would have much more incentive to start loaning out against these excess reserves and the reserves would become required reserves.
By switching to use of the term "balances" instead of the more accurate "excess reserves" and "required reserves", Antinolfi and Keister totally miss this occurrence.
In their confusion, they write:
It’s important to keep in mind, however, what determines the total quantity of these balances...banks hold on deposit at the Fed are liabilities of the Federal Reserve System. The other significant liability is currency in the form of Federal Reserve notes. Together, this currency and these deposits make up the monetary base, the most basic measure of the money supply in the economy. The composition of the monetary base between these two elements is determined largely by the amount of currency used by firms and households (both in the United States and abroad) to make transactions and by banks to stock their ATM networks.This is really incredible! They are completely ignoring the fact that a lower interest rate on reserves would provide incentive for banks to move funds from excess reserves to required reserves, which would cause banks to loan out more money (That's the only way to get it into required reserves). The key is not TOTAL reserves (excess + required) but where the funds are, in excess (where money is not loaned out against reserves) or required (where money is loaned out against the reserves)
What determines the size of the monetary base? As with any other institution’s balance sheet, the Fed’s dictates that its liabilities (plus capital) equal its assets. The Fed’s assets are predominantly Treasury and mortgage-backed securities, most of which have been acquired as part of the large-scale asset purchase programs. In other words, the size of the monetary base is determined by the amount of assets held by the Fed, which is decided by the Federal Open Market Committee as part of its monetary policy.
It’s now becoming clear where our story’s going. Because lowering the interest rate paid on reserves wouldn’t change the quantity of assets held by the Fed, it must not change the total size of the monetary base either. Moreover, lowering this interest rate to zero (or even slightly below zero) is unlikely to induce banks, firms, or households to start holding large quantities of currency. It follows, therefore, that lowering the interest rate paid on excess reserves will not have any meaningful effect on the quantity of balances banks hold on deposit at the Fed.
Note: Although the title of the post is titled, Interest on Excess Reserves and Cash “Parked” at the Fed. Antinolfi and Keister seem to at times discuss the interest rate for total reserves and at other time the interest rate on excess reserves, but in either case it would provide incentive for banks to move funds from excess reserves to required reserves, i.e. loan money out on reserves to earn income, when the other option would be to earn less income-- or be charged interest ( a negative interest rate.)
In other words, total confusion by these New York Fed economists, who clearly have no idea of the dramatic consequences, if the Fed started lowering the interest rate on either excess reserves or total reserves. That banks would have major incentive to start moving the funds from excess reserves to required reserves. Loaning the funds out has the potential to explode the money supply (because of the new loans) by a multiple of the $1.5 trillion plus now sitting as excess reserves. Antinolfi and Keister completely fail to recognize this possibility. Because of their failure to recognize the difference between total reserves, required reserves and excess reserves, and switching midstream into a discussion of "balances", they have made a major error that fails to recognize how a lowering of interest on either excess reserves or total reserves could explode the money supply and thus cause a huge false economic boom and massive price inflation.