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Bernanke has said he would not let it get to zero because to put it down to zero may negatively effect the Fed Funds Market...
Related: One thing that I have been trying to get some data on is how much of the Treasury auctions are going out via Treasury Direct and trend.
I think we ran some comments out a week or two ago where we found some WSJ info that showed that interest rates are in effect negative out to about the six month point due to the Dealer spread... why would a corporate Treasurer not go to Treasury Direct and get the bonds directly from the Treasury without paying a Dealer?
As rates continue to collapse out the term this will only get worse. Eventually Corporate Treasurers are going to get wise (Free Giants and Jets tickets probably only go so far) and boot their dealers and just set up their own Treasury Direct accounts.
This could put Dealers out of business, and if the Fed/Treasury blow the dealers out of business how can the the Fed conduct OMOs if the dealers are out of business?
I think I looked at the recent 4-week auction and the bid/ask spread was about $700 per $1M issued.
There looks like there could be a good amount of excess margin in that...
Overall it looks like the Fed/treasury are making it hard for PDs to stay in business (the model does not make economic sense at zero out the term) and the trend seems like it is going to get worse...
Overall it looks like the Fed/treasury are making it hard for PDs to stay in business (the model does not make economic sense at zero out the term) and the trend seems like it is going to get worse...
Think of it as a loss leader, the PDs pay their dues so they get to be in the room whenever the Fed has to put out fires by pouring money on them.
Scott considers the issue mainly from the point of view of the Fed's target Federal Funds rate. Paying interest on reserves sets a floor under the variability of the Fed Funds rate, because no bank will lend another bank reserve funds for a rate lower than what they would receive from simply holding the reserves and collecting interest on them.
The monetarists tend to think banks lend their reserves, and so paying interest on the reserves constitutes a disincentive to lend them. They thus think reducing or elimination the IOR will expand lending. MMT and other defenders of endogenous money creation deny this.
It seems to me that the interest paid on reserves effectively reduces the cost of acquiring them. It allows the Fed to establish a real rate for acquiring reserves via interbank lending that is lower than the nominal Fed Funds rate. This presumably gives the Fed more flexibility with regard to the zero bound. (not sure this is true; it's something that just occurred to me.)
I believe Bernankes concern with the Fed Funds market was that a ZIRP would provide no incentive for banks to engage in FF market so why would they do it? Why lend reserves to someone for 0%?. Just lay off the staff and save money.
So he has to keep it at 0.25 so at least there is some yield for them so they stay "in the business" and there still is a Fed Funds Market...
But I wonder if he has such a concern for the PDs and their participation in the OMOs?
What I'm concerned about is that they will "find a reason" to raise interest rates unexpectedly in order to save the Dealer system if they are not seeing this and it surprises them...
The fed is in charge of the policy rate. It can set the rate to zero, or it can set the rate somewhere that is not zero either through the FFR and OMO or paying IOR.
Based on all the comments at AB, Asymptosis, and here, the answer I"ve come to:
The first-order effects of dropping IOR to zero would be minimal to none -- despite claims of (semi-, demi-, quasi-, and market-) monetarists. It would not "push" more money into the real economy (increase lending hence purchases/velocity), because there aren't a lot of good real-economy loans to make out there. Neither banks nor borrowers see risk-return lending/borrowing opportunities that are attractive. Pushing on a string.
Giving banks incentives to hold physical currency, or in other language reducing the returns on their reserve holdings, would not affect that situation.
An aside: currency is actually *less* liquid than reserves. All those trucks and warehouses and security guards to manage...
But (as you guys suggest here) it would throw serious wrenches into the financial system by breaking various financial entities' business models. You guys have pointed out the problems facing primary dealers. Others point to main-street banks. And etc. In short, colorful, and imprecise language, the financial system would go schitzo.
And that could (would?) have (profound?) negative second- and third-order effects on the real economy.
Which kind of explains why the Fed instituted it when they did. We can at least say they understand the business models of various key financial entitities. So as rates went to zero, they instituted IOR to prevent that lockup.
Which kind of explains why the Fed instituted it when they did. We can at least say they understand the business models of various key financial entitities. So as rates went to zero, they instituted IOR to prevent that lockup. Seem right?
Steve, what I've heard from Warren, Bill Black, etc. is that the Fed was late in recognizing the liquidity problem. According to Warren, liquidity should never be a problem for solvent institutions under a fiat system in which the cb is the LLR, and so the amount reserves is not an issue. The question was really one of which institutions were insolvent. Bill Black claims that many of the TBTF's were insolvent and the law requires that they be put into resolution. He rejects the claim that this could not be done in a timely fashion or would have been disruptive.
When a financial system is freezing up, the answer is to provide liquidity to solvent firms, reduce the interest rate, and put insolvent institutions into resolution (banks) or receivership (non-bank firms).
Fiscal policy should also have been loosened quickly to prevent the financial crisis from affecting the real economy.
They got it all wrong instead and we are still trying to dig out of the mistakes.
12 comments:
Bernanke has said he would not let it get to zero because to put it down to zero may negatively effect the Fed Funds Market...
Related: One thing that I have been trying to get some data on is how much of the Treasury auctions are going out via Treasury Direct and trend.
I think we ran some comments out a week or two ago where we found some WSJ info that showed that interest rates are in effect negative out to about the six month point due to the Dealer spread... why would a corporate Treasurer not go to Treasury Direct and get the bonds directly from the Treasury without paying a Dealer?
As rates continue to collapse out the term this will only get worse. Eventually Corporate Treasurers are going to get wise (Free Giants and Jets tickets probably only go so far) and boot their dealers and just set up their own Treasury Direct accounts.
This could put Dealers out of business, and if the Fed/Treasury blow the dealers out of business how can the the Fed conduct OMOs if the dealers are out of business?
Resp,
@ Matt
Capitalism asserts that markets are self-correcting. :o
tom,
I think I looked at the recent 4-week auction and the bid/ask spread was about $700 per $1M issued.
There looks like there could be a good amount of excess margin in that...
Overall it looks like the Fed/treasury are making it hard for PDs to stay in business (the model does not make economic sense at zero out the term) and the trend seems like it is going to get worse...
Overall it looks like the Fed/treasury are making it hard for PDs to stay in business (the model does not make economic sense at zero out the term) and the trend seems like it is going to get worse...
Think of it as a loss leader, the PDs pay their dues so they get to be in the room whenever the Fed has to put out fires by pouring money on them.
Scott Fullwiler wrote a paper a few years ago on IOR.
http://www.cfeps.org/pubs/wp-pdf/WP38-Fullwiler.pdf
Scott considers the issue mainly from the point of view of the Fed's target Federal Funds rate. Paying interest on reserves sets a floor under the variability of the Fed Funds rate, because no bank will lend another bank reserve funds for a rate lower than what they would receive from simply holding the reserves and collecting interest on them.
The monetarists tend to think banks lend their reserves, and so paying interest on the reserves constitutes a disincentive to lend them. They thus think reducing or elimination the IOR will expand lending. MMT and other defenders of endogenous money creation deny this.
It seems to me that the interest paid on reserves effectively reduces the cost of acquiring them. It allows the Fed to establish a real rate for acquiring reserves via interbank lending that is lower than the nominal Fed Funds rate. This presumably gives the Fed more flexibility with regard to the zero bound. (not sure this is true; it's something that just occurred to me.)
I believe Bernankes concern with the Fed Funds market was that a ZIRP would provide no incentive for banks to engage in FF market so why would they do it? Why lend reserves to someone for 0%?. Just lay off the staff and save money.
So he has to keep it at 0.25 so at least there is some yield for them so they stay "in the business" and there still is a Fed Funds Market...
But I wonder if he has such a concern for the PDs and their participation in the OMOs?
What I'm concerned about is that they will "find a reason" to raise interest rates unexpectedly in order to save the Dealer system if they are not seeing this and it surprises them...
The fed is in charge of the policy rate. It can set the rate to zero, or it can set the rate somewhere that is not zero either through the FFR and OMO or paying IOR.
Hey all:
Based on all the comments at AB, Asymptosis, and here, the answer I"ve come to:
The first-order effects of dropping IOR to zero would be minimal to none -- despite claims of (semi-, demi-, quasi-, and market-) monetarists. It would not "push" more money into the real economy (increase lending hence purchases/velocity), because there aren't a lot of good real-economy loans to make out there. Neither banks nor borrowers see risk-return lending/borrowing opportunities that are attractive. Pushing on a string.
Giving banks incentives to hold physical currency, or in other language reducing the returns on their reserve holdings, would not affect that situation.
An aside: currency is actually *less* liquid than reserves. All those trucks and warehouses and security guards to manage...
But (as you guys suggest here) it would throw serious wrenches into the financial system by breaking various financial entities' business models. You guys have pointed out the problems facing primary dealers. Others point to main-street banks. And etc. In short, colorful, and imprecise language, the financial system would go schitzo.
And that could (would?) have (profound?) negative second- and third-order effects on the real economy.
Which kind of explains why the Fed instituted it when they did. We can at least say they understand the business models of various key financial entitities. So as rates went to zero, they instituted IOR to prevent that lockup.
Seem right?
Nothing happens. The yield curve flattens, that's it.
Total beginner here. How are main-street banks affected?
Less income? How significant is that effect?
Which kind of explains why the Fed instituted it when they did. We can at least say they understand the business models of various key financial entitities. So as rates went to zero, they instituted IOR to prevent that lockup.
Seem right?
Steve, what I've heard from Warren, Bill Black, etc. is that the Fed was late in recognizing the liquidity problem. According to Warren, liquidity should never be a problem for solvent institutions under a fiat system in which the cb is the LLR, and so the amount reserves is not an issue. The question was really one of which institutions were insolvent. Bill Black claims that many of the TBTF's were insolvent and the law requires that they be put into resolution. He rejects the claim that this could not be done in a timely fashion or would have been disruptive.
When a financial system is freezing up, the answer is to provide liquidity to solvent firms, reduce the interest rate, and put insolvent institutions into resolution (banks) or receivership (non-bank firms).
Fiscal policy should also have been loosened quickly to prevent the financial crisis from affecting the real economy.
They got it all wrong instead and we are still trying to dig out of the mistakes.
I tried to summarize the discussion (or at least my conclusions from the discussion) here:
http://www.asymptosis.com/answers-taking-ior-to-zero.html
http://www.angrybearblog.com/2012/01/answers-taking-ior-to-zero.html
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