Monday, July 23, 2012

Alan Blinder: Release the Trillion in Excess Reserves!!

In a remarkable op-ed in WSJ, Alan Blinder, professor of economics and public affairs at Princeton University, previously head of President Bill Clinton's Council of Economic Advisors (January 1993 - June 1994), and Vice Chairman of the Board of Governors of the Federal Reserve System from June 1994 to January 1996, is calling for the Federal Reserve to charge banks if they continue to hold their funds as excess reserves, instead of loaning them out. He writes:
I have two out-of-the-box suggestions to make, one in today's column and another in a companion piece soon. 
The simpler option is one I've been urging on the Fed for more than two years: Lower the interest rate paid on excess reserves. The basic idea is simple. If the Fed reduces the reward for holding excess reserves, banks will hold less of them—which means they will have to find something else to do with the money, such as lending it out or putting it in the capital markets.

The Fed sees this as a radical change. But remember that it paid no interest on reserves before the 2008 crisis and, not surprisingly, banks held practically no excess reserves then. In early October of that year, Congress gave the Fed authority to pay interest on reserves, which it promptly started doing. When the Fed trimmed the federal funds rate to its current 0-25 basis-point range in December 2008, it also lowered the interest rate on reserves to 25 basis points, where it has been ever since.

My suggestion is to push it lower in two stages. First, test the waters by cutting the interest on excess reserves (in Fedspeak, the "IOER") to zero. Then, if nothing goes wrong, drop it to, say, minus-25 basis points—that is, charge banks a fee for holding their money at the Fed. Doing so would provide a powerful incentive for banks to disgorge some of their idle reserves. True, most of the money would probably find its way into short-term money-market instruments such as fed funds, T-bills and commercial paper. But some would probably flow into increased lending, which is just what the economy needs.
File this under Keynesians gone wild. Alan Blinder has not only gone topless but also bottomless. There are currently $1.45 trillion in excess reserves. This is money banks are keeping with the Federal Reserve on deposit and not loaning out. It is in a sense money that Bernanke has printed but has not entered the economy. If this money gets into the system, massive price inflation could occur. Indeed, given the fractional reserve system, the amount of money entering the system could be a multiple of the $1.45 trillion.

Currently, the interest rate paid on excess reserves is 0.25%, if it is ultimately dropped to a negative number, it is possible the entire $1.45 trillion could flow out very rapidly, flooding the economy. It would result ultimately in massive price inflation.


  1. OMG!
    The current fractional reserve money multiplier is 10. It would take time for the multiplier to work, but the $1.45 Trillion could be multiplied to $14.5 Trillion if fully loaned-up. That’s on top of the current M2 (not seasonally adjusted) money supply of $10 Trillion. Alan Blinder is a wacko Keynesian who has just called for the Money Supply to be more than doubled!
    Robert, your quote “Massive Price Inflation” is a gross understatement! To use Fed-speak, “Expectations would not remain grounded” and we would actually experience hyperinflation, assuming of course the Fed did not take action to raise interest rates ala Paul Volcker.

  2. On the one hand, this would be terrible, and maybe result in hyperinflation (which is why it won't happen). On the other hand, things are going to meltdown sooner or later, let's get it over with!

  3. Well, in his defense we have already already tripled the money supply in the last few years.

    I say let the Keynesians have their way.

    IN FACT, in a huge change of strategy I think all Austrians should call for the Keynesians to be allowed to fully realize their money printing dreams to their fullest extent.

    Let's put to bed this non-sense of not having "spent enough" before the Great Depression.

    Even further, I'm no fan of them slowly doling out the various forms of QE a la Japan to create decades of misery.

    As Austrians, we should say: "I whole heartedly disagree with your ideas, but since we are so far along I now think we should complete your experiment- so print it up as much as you want!!!"

    That way, we can get the collapse over with quickly, repudiate the debt-then move on.

    Yes, Yes, Yes!

    I'm not for 20 years of Japan like misery.

    1. Spoken like someone who has already a large stash of gold and silver! (also like me!) Yes, bring it on, Keynesians!

    2. That still won't be enough for them.

    3. Exactly Anon @ 3:35.

      Paul's been exposed in the MSM since his primary debates in the summer of 06'. Once he bonked me over my silly head I moved my entire 401k into gold in the summer of 06' via a self directed IRA. Best thing I ever did.

      I've had to restock some since then but I have little compassion for people that have ignored the message out there in the MSM for a good 6+ years now...even if you don't make a lot you can put away a paltry amount of gold/silver and be better off then 98% of people out there.

      Additionally, there's an argument to be made that the "compassionate" thing to do is let it all blow up as quickly as possible so the misery is not prolonged even for those with no hard currency(or assets).

  4. Robert,

    Have you read Mish's arguments on why he thinks "excess reserves" are "fictional reserves"? He is heavily influenced by Steve Keen.

    It is way too technical for my level. He feels these "excess reserves" hold no threat whatsoever for hyperinflation due to banks being insolvent rendering traditional money multiplier macro/textbook analysis inapplicable. He also cites Japan where the QE since 1999 increased excess reserves and base money by 2 times but this did not translate into inflation and increased credit lending.

    I would like it if you would point the flaws in his analysis and perhaps even rebut it completely, I read both your blogs regularly (Though I only recently started reading his posts just to get another perspective from a self-proclaimed 'Austrian' money manager).

    Thanks a lot and keep up the good work!

    1. "I read both your blogs regularly", is there another RW blog also? I only knew about this one.

    2. I wouldn't doubt his Austrian credentials. The inflationist/deflationist arguments hinge more on whether a particular theory is applicable than whether it is correct per se.

    3. I agree with Inquisitor; Mish is a solid Austrian. His position is not that hyperinflation could never happen here, but that the necessary conditions haven't been met yet. First, banks are too capital impaired to go off the Fed's life support system of paying them for excess reserves, and second, the Fed's steering wheel is no longer hooked up to the tires. Bernanke can spin the wheel all he wants, but he's only pretending to drive. It would take a big shift in crowd psychology to get hyperinflation, and once that happened, the banks' gravy train of fiat money would come off the tracks.

    4. Just because the banks have money to lend, doesn't mean they will. People are deleveraging and banks are recapitalizing. The Fed can't force them to lend.

    5. Thank you for the link Anon.

      If I understand properly Mish says the money multiplier isn't going to be put into effect on the "reserves" as MMT is based on capital(like a downpayment for example)...and the reserves will be simply covering asset/loan performance losses. (Hence his argument that there aren't "excess" reserves)

      I think he's got a good point personally. He uses some nice charts showing how it's working out in Japan.

      Of course, it's still bad news for the U.S. as it means decades of stagnation even without hyperinflation if Mish is right. Mish does think the problems aren't going to go away and things they are structural as well.

      Some issues though with what I read as I understand it:

      #1 He doesn't acknowledge that the excess reserves are still inflationary even though by his argument not subject to the MMT.
      #2 He doesn't talk about how QE(1..2..3..etc.) doesn't just go into reserves but leaks out all over the place AND subject to MMT. Per wiki:

      "The new money could be used by the banks to invest in emerging markets, commodity-based economies, commodities themselves and non-local opportunities rather than to lend to local businesses that are having difficulty getting loans."

      Not only is the above inflationary, much of it may also be subject to MMT.

      I'm not sure I have it all right as I'm just a businessman/layperson, but I very much appreciate the link to Mish and another perspective.

      I've long been perplexed on the actual process of how the Fed would deal with the excess reserves...Mish is saying they can basically be ignored...I guess if that's the plan and assuming Mish's Japan figures are correct that might be a possibility. But it's just one aspect of a bigger problem still both structurally and from an inflation stand point(just less so if MMT isn't a factor for reserves).

      I think more QE's compound the issue...but he sticks to the topic of reserves.

      The only other thing I'll note is some of his figures are based on 2010...I think the loan performance figures have gotten much worse in the last two years and it's an easy number to hide short term. (extend and pretend)

  5. Maybe the banks would take the Fed to court, contending that it doesn't have power under the commerce clause or Federal Reserve acts to impose a negative interest rate.

    Then the court agrees but proclaims that the negative interest rate is a tax that the Fed is empowered to assess. After all, the Fed's profits are allocated to the government's treasury, not to the cartel's ostensible owners.

  6. Never gonna happen.

    Remember Robert's post about Bernanke keeping the FFR steady at 0.15 percent? I'm not sure if this is exactly correct in the mechanics, but if the banks can borrow from the Federal Reserve at 0.15 percent, and then put that money into excess reserves that pays interest at a rate of 0.25 percent, seems like it (1) incentivizes banks to stockpile excess reserves (risk free profit); and (2) incentivizes banks to borrow more from the Federal Reserve (at 0.15%) and then "invest" those funds in excess reserves (at 0.25%).

    In other words, banks get a government handout equal to the arbitrage on $1.45 trillion in excess reserves. After a few years, that will provide the government gravy to pad their balance sheets enough to absorb the massive real estate losses which they still need to absorb as time goes on. By then (est. 3-5 years), banks will start loosening credit standards again, cheap credit will flood the economy, prices will rise and the boom-bust cycle will repeat itself yet again. History books will say "Keynesians save the economy and animal spirits of capitalism ruin it again."

    1. The fed funds market is a market between banks, not a market where banks borrow from the Federal Reserve. Banks can borrow from the Federal Reserve directly through the Discount Window, the interest rate on this is 1% at the moment, no bank uses it. The Federal Reserve uses Open Market Operations to control the amount of reserves in the banking system, a tool entirely different from the fed funds market, where these reserves then potentially circulate. The stuff of any course on the Principles of Macroeconomics (well maybe not at Austrian departments).

      You are not "exactly correct in the mechanics", in fact it seems to me you have no idea what you are talking about.

    2. Fair enough criticism of my post, but I wouldn't use this self-taught amateur's ignorance of economics as a benchmark for Austrian academics or their students.

      That said, my understanding is that the Federal Reserve uses "repurchase agreements" (e.g. short term loans to member banks) to increase bank reserves and lower the Federal Funds Rate (or interbank lending rate). I know that this is different from the discount window, which (as you observe) loans out funds at a higher rate of 1%. But in substance aren't repos simply collateralized loans of money to the banks, and in order to keep the FFR at target levels (0.15%) wouldn't the repo rates need to be at least that low, if not lower?

      The whole nature of the repurchase market and its use as a tool of monetary policy has me a bit flummoxed, so any help on that point would be appreciated.


  7. He's just grown bored waiting for the crack-up boom!

  8. It's about velocity of money my friends.

  9. Noel Falconer MEconJuly 24, 2012 at 3:15 AM

    What have I been writing these many months? The economy is a catastrophe waiting to happen, and all the high and mighty do is deny that a problem exists.

    Astronomic amounts of money have been printed. They are sitting inert, in those excess reserves and suchlike, but can move at any moment, and when they do this will self-reinforce. THIS IS HOW AN EXPLOSION ESCALATES. Computer trading speeds this so greatly that if the authorites knew what to do - they don't, certainly not that late, nobody does - they wouldn't have time.

  10. Austrian economics is an intellectual cul-de-sac that ddoes not translate to real-world economics. They have no idea of how credit works and stupidly champion the same debt-based monetary schemes that got the world into this mess. Their simple mistake is that they believe backing debt-based currency with gold and silver will solve the problem of boom and bust economic cycles, when anyone with a calculator and a simple understanding of compound interest can easily prove that any debt-based currency will ultimately fail. Of course, when presented with this simple logic, Austrian economists just pretend that it's all about Keynesianism. It's not, and Austrian economics needs to be mocked, jeered and shunned into oblivion.

    1. Gosh... you're smeert.

    2. they believe backing debt-based currency with gold and silver will solve the problem of boom and bust economic cycles, when anyone with a calculator and a simple understanding of compound interest can easily prove that any debt-based currency will ultimately fail.

      The usual Austrian proposal is for the form of money to be determined by actors in the market and that the form of money that will ultimately win out will be actual gold and silver. What exactly do you think you mean by "backing debt-based currency with gold and silver".

      You also seem to have no familiarity with the central Austrian concept of economic calculation. What else is new?

    3. Krugman, you're getting funnier every day. Sad thing is that you don't even know it.

    4. No wonder you are in as Anonymous, you could have put troll and been on target. I suppose you also think that a dollar that is worth less than 3 cents compared to the pre-Fed dollar's value should be considered a blazing success of the Keynesian fiat monetary fiasco. Try this for your new name: Retarded and Oblivious to It.

    5. This is a zeitgeist loser, who doesnt know anything except that free-marketeers are to blame.

      "Debt-based" currency is fractional-reserves in zeitgeist lingo

  11. "Their simple mistake is that they believe backing debt-based currency with gold and silver will solve the problem of boom and bust economic cycles, when anyone with a calculator and a simple understanding of compound interest can easily prove that any debt-based currency will ultimately fail."

    Because I'm a simpleton, please explain to me the above. Seriously.

    Are you saying that the counterparty risk extends beyond those in a contract using whatever "currency" they'd like? Who specifically is saying that we should use paper backed by gold only?(or silver)

    If someone decided to use gold, and took "gold notes" in lieu of the actual item could they not decide whose notes where "safe" or not? Could they not demand physical gold itself?

    I appreciate your time in responding in advance.

  12. The arguments from Mish and Steve Keen are quite compelling. The best explanation I have heard as to why banks are sitting on reserves is that they can't find any credit-worthy borrowers who are willing to take on debt. There is a lot of merit to the model that we live in a credit-based economy, with a fiat-money system tacked on to the back of it

    1. Yes, perhaps the most clear outcome of the exchange is how both the paleo-Keynesians and Austrian share the quaint myth of fractional reserve lending. Try the test - go into any bank and ask the loan officer on duty what his bank's reserve levels are. Lending comes first, reserves get balanced later.
      The old Keynesians offer magic ponies but the Austrians offer ones that poop gold nuggets.

    2. ABCT does not require fractional reserve lending, just a scenario where the interest rate stops coordinating production. That is precisely what happens when a central bank enables banks to extend credit to every single person who wants it. There are plenty of Austrians who have no issue with fractional reserve

  13. Thank what would happen in Canada or Australia, they have zero reserve requirements, so the multiplier would be infinite! So the price level would be infinite. Wait, why isn't it already infinite?

    Because the multiplier you think in terms of doesn't exist.

    Charging interest on reserves is simply a tax on banks, capital would be withdrawn from the banking system if we ensured that banks are unprofitable by charging them enough IOR, so the result would be the opposite to what you think.

    1. "they have zero reserve requirements, so the multiplier would be infinite! "

      No, that doesnt follow. They would still have reserves, but they would determine the amount of reserves necessary(ofc keeping in mind central banks guarantee etc.)