Monday, January 18, 2010

'Lending Reserves': NY Fed Report Disputes Remarks by Chairman

A recent paper published by a research division of the NY Fed is titled: Why Are Banks Holding So Many Excess Reserves?

From the Report Summary:
The buildup of reserves in the U.S. banking system during the financial crisis has fueled concerns that the Federal Reserve’s policies may have failed to stimulate the flow of credit in the economy: banks, it appears, are amassing funds rather than lending them out. However, a careful examination of the balance sheet effects of central bank actions shows that the high level of
reserves is simply a by-product of the Fed’s new lending facilities and asset purchase programs. The total quantity of reserves in the banking system reflects the scale of the Fed’s policy initiatives, but conveys no information about the initiatives’ effects on bank lending or on the economy more broadly.

Many in the financial media and policy makers have been lamenting that the banks are "sitting on their reserves" and not lending them out; and others predict that when they finally do lend them out there will be large inflationary effects . But here we have the research arm of the policy implementing Federal Reserve Bank of NY more than just implying that reserve balances are not loaned out, and that reserve balances are just a necessary accounting record of the scale of Fed operations and should not be looked at in judgement of future economic outcomes.

This revelation by the NY Fed should not be a surprise to readers of this blog. But perhaps it is to Chairman Bernanke, who stated in a speech as recently as October 2009:

The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets..... banks could find it profitable to be more aggressive in lending out their reserves, which in turn would produce faster growth in broader money and credit measures and,
ultimately, lead to inflation pressures...

So which side is correct? I think it is time for some of the researchers at the NY Fed to "man up" and give a presentation to the Chairman and the FOMC.


Larry Staton Jr. said...

After the NY Fed gives a lesson to Bernanke, perhaps they can give one to the economists at the Cleveland Fed for this commentary.

mike norman said...


Yes, exactly. How does the Cleveland Fed explain, then, why there were $600 billion more in loans outstanding at commercial banks when system reserves were only $7 billion back in Sept 2008? By their logic there is no way that should have occurred because the banks would not have had the reserves to "lend out." They don't get it: it's a function of price, not quantity. Reserve balances reflect central bank interest rate (price) targeting, that's it.