An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
Maybe how the Fed provided USD liquidity to European institutions in 2008, the US banks will need the ECB to provide Euro liquidity to US banks in 2011...
Maybe how the Fed provided USD liquidity to European institutions in 2008, the US banks will need the ECB to provide Euro liquidity to US banks in 2011...
interesting...based on the way the ECB seems so reluctant to "bailouts", I wonder if they'd do it.
Yes I believe even Greece govt securities are acceptable collateral for ECB open market operations...
I believe the ECB maintains a list of acceptable securities, if a nation's govt debt was to be "kicked off" that list, it perhaps would be the end of the Eurosystem as we now know it.... I think the policymakers over there realize this so they instead make Greece go thru these cathartic austerity measures to give them political cover to keep the Greece govt securities on the list of acceptable securities.... Resp,
something must be going on there as Mike points out the CDS of the Core nations is now spiking and US banks are getting hit (BofA back under $10) so perhaps these events are related... the problems may this time be coming from Europe...
Like you said above and I didn't get. If they have to provide Euro liquidity surely the Euro will fall and the race to the bottom will continue. I wonder if Dr. Bernanke will experiment a little more this time. Is he opposed to a stronger dollar??
Yes, it puts the US at an export disadvantage, and the president has said he wants to double exports. That cannot happen with the dollar getting stronger and making US goods more expensive abroad.
So Ben is buying Treas and increasing the Money Supply? I'm not quite sure if there is a slight of hand going on there. I've heard implications that there is some kinda flipping going on between the banks and the Fed. I'm totally at a loss here. And also that MMT says the money supply is really not being increased, which would cause a disconnect it seems between the real strength of the dollar and what is common thought. This kinda fits with my distant past memories of similar situations when the dollar became strong suddenly. Is this a possibility or have the markets got it right and we should expect a continuation of the 'artificial' rise in equities??
Buying tsy's doesn't increase the money supply (in circulation). It increases bank reserves (monetary base). It's just a shift in composition and maturity of non-government saving. It doesn't affect the amount of non-government net financial assets.
I heard one MMT person actually say that money was actually being taken out of circulation. And I have no problem with what you said about the (base) or above either, but doesn't that set up a day of reconing with the 'real' value of the dollar?
Super cool! Many thanks. I'm right now under heavy fire from my German friends for being a traitor to the core of Europe — the good responsible nations. I do not watch the CDS market regularly but from now on I will. Must post this tomorrow in German!
"I heard one MMT person actually say that money was actually being taken out of circulation. And I have no problem with what you said about the (base) or above either, but doesn't that set up a day of reckoning with the 'real' value of the dollar?"
Anonymous, Why would it lead to "a day of reckoning" for the dollar. Do you know something that the bond market don't? They are happy buying 30yr tsys at historically low rates.
Much ado about nothing if you understand how the monetary system works.
Much ado about nothing if you understand how the monetary system works.
wouldn't that be b/c those funds will never see the "light of day" so to speak as they are all reserves anyway? The question about bonds or reserves simply becomes the level of interest paid out...and once there's no other option then there's no other option and that's the end of that. Since when did banks need to get a real return (aka a "free ride") on their reserves in the first place?
There has to be a transmission mechanism from reserves to spending, and this is usually presumed to be the money multiplier. But the money multiplier in normal times was just an ex post accounting record not an ex ante cause. What MMT had been asserting was shown to be the case through QE and paying interest on reserves. The large build up of reserves was unable to create even a slight bit of inflationary pressure, as the Fed had hoped it would.
The transmission mechanism for getting currency into the economy is government expenditure, and the transmission mechanism for the creation of credit money by the private sector is demand for loans by creditworthy borrows. That has not happened.
While excess reserves (monetary base) as gone exponential, M2 has fallen and inflation remained low. But don't worry, the inflationistas assure us, hyperinflation is just around the corner. Really?
If US banks have Euro denominated liabilities that are being called in, and they cannot easily provide the Euros, then US banks I believe would have to sell USDs for Euros which would make the USD go down.
(This is of course all hypothetical at this point) This would be the opposite of what happened in 2008 when Euro banks got called on USD liabilities, they had to sell Euros to get the USD and the USD rallied until the Fed finally went the full monty with the FOREX swaplines.... then the USD rally was stopped cold.
I cant see how US entities could be short Euros anywhere near as much as the Euro intitutions were short USDs back in 2008.... but it could still be a substantial problem for the already stressed US bank balance sheets... and perhaps could put pressure on the USD until the ECB would perhaps step up and provide US institutions whatever Euro liquidity they needed short term.
“I heard one MMT person actually say that money was actually being taken out of circulation. And I have no problem with what you said about the (base) or above either, but doesn't that set up a day of reconing with the 'real' value of the dollar?”
Anon, On the above questions:
First on money being taken out of circulation because of QE:
This was implied because taking the treasuries out of the market during QE means the interest payments, on those treasuries, are taken out of the market too (the FED refunds its revenues, less its operational expenses, back to Treasury, so those interest payment basically go right back to Treasury after the Treasury makes them.) This means that the private sector will not get those payments on the treasuries that QE bought. Therefore, money supply will be less over time than it would have been.
On day of reckoning:
I assume you mean with the reserve increase that your assumption is that that scenario would lead to more money being lent by banks, therefore money supply could explode via those reserves. This is not correct because bank lending is not reserve constrained – the money multipler is a “myth.” Banks can always make loans, no matter what reserves they have. For example, just by the action of lending past reserve requirement, the Fed charges the bank for a loan. So lenders do not check their reserve capacity before making loans - the only restrain on lending is if the loan will be profitable to the bank after borrowing from the Fed if reserves are already fully taken. So the theory is that banks will make X amount of loans, with the condition being profitable or not to do so, no matter what the size of reserves. So increased reserves will not result in any more or less loans basically.
Mario, On “wouldn't the bank's reserves be increased automatically once the new loan was made? Are reserves ever "fully taken"?” I do not fully understand the accounting. I think the loan deposit, whether with the lending bank or another bank, creates reserves in the “system.” Do they offset? Reserves reduced from the loan but then added back from the deposit? I do not know.
I do not understand the details of the accounting, so I am not sure if this lending would increase reserves for the system as a whole or if it would be horizontal and system wide reserves would stay the same. For example, does the reserve loan to the lending bank by the Fed decrease system-wide reserves but then the customer’s deposit from the bank loan (or a third party’s deposit of those funds if the borrower pays another party with the funds) increases system wide reserves by the same amount and they off-set. Or is the final accounting, the Fed has increased reserves by the amount of the reserve loan to the lending bank? Anyone know?
On “Also how does this relate to bank's being required to put money down on their loans they make? Is that the reserves or something else?”
I do not think banks put down any money. From what I have read from Warren Mosler’s posts on this, I “think” bank loans are made regardless of reserve situation – reserve situation only enters into the decision on cost to make the loan. And the Fed bank loan is straightforward. For example, if a bank is within its reserve requirement, then no loan from the Fed to make the loan to the customer. If the loan would fall outside of the lending bank’s current reserve requirement, then a loan from the Fed automatically happens (bank does not request it or anything, it is just noted by the Fed and interest starts accruing to the bank.) So in the latter case, it would just directly cost the bank more to make the loan to the customer because the bank would have to pay interest to the Fed to meet its reserve requirement via that Fed loan. Mosler implies this could be done to any amount. I guess the only question on limit is if a bank is deemed insolvent and can meet deposit demands or not and then the FDIC would take it over.
“Plus if reserves are always there through the Fed, why have them accounted for in the first place? What are they doing exactly for the banks/loans?”
I guess it is just accounting and there is no real limit – just a soft cap via interest rates. The Fed will always give a solvent bank a Fed loan (I am assuming this from reading Mosler and Ed Harrison and Cullen Roche) to meet that bank’s reserve requirements. So, I guess the Fed can only soft-cap lending via the Fed funds rate (jack them up high enough that banks cannot make profitable loans past their reserve requirements and/or force banks to increase rates to customer which would curtail the private sectors desire to borrow. )
Would someone else help us on the exact mechanics of this?
While you both are now more qualified to be Treasury Secretary than Geithner, you should perhaps correspond with JKH or Ramanan on this topic of "reserves".
Reserves are a regulatory construct the way I look at it. Really the only people who should be concerned about Reserves are bank Regulators and if you are the compliance officer in a bank.
Reserve levels dont provide any insight into the economy or economic activity (except for morons). That said, as an academic exercise, suggest try to engage JKH into posting a typical banks balance sheet details and you will see how bank accounting uses the concept of "reserves" to build a bank balance sheet and this may be academically informative for you (and me probably!)
Ill see if I can find any previous posts on reserves and post them here....
"On “wouldn't the bank's reserves be increased automatically once the new loan was made? Are reserves ever "fully taken"?” I do not fully understand the accounting. I think the loan deposit, whether with the lending bank or another bank, creates reserves in the “system.” Do they offset? Reserves reduced from the loan but then added back from the deposit? I do not know."
There are two ways that reserves are created by the Fed, one is Treasury spending, and the other is loaning to banks against collateral.
The excess reserves over required reserves in the system are neutralized by issuance of tsys in offset of the deficit to drain excess reserves to maintain the Fed's target rate if it is not paying a support rate on excess reserves and doesn't want the target rate to fall to zero.
Loans (made against bank capital) create deposits. This creates a reserve requirement corresponding to the deposit size. If the depost is spent outside the bank, then the bank also needs reserves to clear its checks in the interbank market.
Banks get required reserves and reserves for settlement in several ways — through internal operation, interbank exchanges, borrowing from other banks in the interbank market, and also, usually as a last resort by borrowing from the Fed against collateral, generally tsys.
From that link, "They can borrow from each other in the interbank market but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank "
Would the above be the basis that QE did nothing as far as money supply potential because the banks could have always posted the bonds that QE bought as collateral for loans from the Fed or sold them outright to the Fed anyway. Therefore QE was completely neutral in money supply potential?
(Note that by money supply potential I mean potential for more loans/added credit in the system.)
Based on “Does the bank’s reserve fall as a consequence? Not necessarily because it depends on other transactions. What happens if the car dealer also banks with Bank A (the consumer’s bank)? Then Bank A just runs a contra accounting adjustment (debit the borrower’s loan account; credit the car dealer’s cash account) and the reserve balance doesn’t change even though a settlement has taken place. There are more complicated situations where the reserve balance of Bank A is not implicated. These relate to private wholesale payments systems which come to the settlements system (aka the “clearing house”) at the end of the day and determine a “net position” for each bank. If Bank A has more cheques overall written for it than against it then its net reserve position will be in surplus.”
which is looking at reserves changes from the perspective of one bank, one can assume that bank lending, across the whole system, always cancels, if the money stays in the system. The above example uses one bank, stating that if the proceeds from a loan come back as deposits to that same bank, there is no change in that bank’s reserves. Therefore, I assume if the proceeds go to another bank, then isolating that one loan would mean the lending bank’s reserve go down by the amount of the loan and the other bank that receives the loan proceeds as a deposit has its reserves go up by the same amount, so a system containing both of those banks, sees no change in reserves. Therefore, one can conclude that all bank lending, if the proceeds stay in the system, are horizontal with no change system-wide, right?
But if the proceeds went to buy imports and the proceeds left a system to go to a foreign sector’s system (foreign sector’s central bank holds those proceeds as reserve currency), then it would be a loss of reserves for a system, right? But if that foreign sector left the proceeds in the system of the buyer of its imports (Chinese exporters buy US bonds for example), then again the system would not change?
matt that link is awesome by bill (as usual of course).
There are a number of gems in this one...but this one stuck out to me in regards to this discussion:
"The major insight is that any balance sheet expansion which leaves a bank short of the required reserves may affect the return it can expect on the loan as a consequence of the “penalty” rate the central bank might exact through the discount window. But it will never impede the bank’s capacity to effect the loan in the first place."
So this answers my question as to what is the purpose of reserves anyway...they simply facilitate the interbank market to handle all daily transactions in the economy. It has NOTHING to do with "backing" the loan per say. It has to do more with "accounting for" that loan (new money) in the economy. If the lending bank doesn't do that by increasing their reserves accordingly, then they will likely get penalized for going below the reserve requirement and be forced to use the discount window. It's interesting to note that the Fed put out a paper a while back which I read that discussed how during the GFC most banks decided to rather loan to each other in the interbank market at higher rates than to go to the discount window at the Fed. It seems to be that feared. Interesting indeed.
@crake
it would appear based on what bill is saying that reserve levels grow as more loans are made simply b/c there's more transactions now taking place in the economy, but that is the responsibility of the bank to manage their reserve levels based on the amount of loans they are issuing otherwise if they are under reserved then they will get penalized.
he also seems to state that net reserve levels only increase through vertical transactions (government to non-government), and I am assuming this includes whenever a new loan is made b/c the Fed (government) increases the reserves of a bank (non-government). Check me if I'm wrong. The quote below is referring to interbank lending (non-gov to non-gov) of reserves which does NOT increase net reserve levels for obvious double-entry accounting dynamics.
"We might qualify the statement that banks do not lend reserves. In a sense, they can trade them between themselves on a commercial basis but in doing so cannot increase or reduce the volume of reserves in the system. Only government-non-government transactions (which in MMT are termed vertical transactions) can change the net reserve position. All transactions between non-government entities net to zero (and so cannot alter the volume of overall reserves). I explain that in more detail including the implications of that point in the trilogy of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3. It helps to understand why budget deficits place downward pressure on interest rates – which is contrary to the mainstream macroeconomics textbook depiction captured by “crowding out”."
cool stuff for sure. I also liked that contra-accounting piece you mentioned too Crake. Pretty interesting stuff. Cheers!
this quote from the article Matt linked really clearly explains the sole purpose of reserves. Fascinating, simple, and makes sense to me!! It's incredible just how wrong most economists and professionals have this stuff!!! It's really very practical and functional.
"The commercial banks are required to keep reserve accounts at the central bank. These reserves are liabilities of the central bank and function to ensure the payments (or settlements) system functions smoothly. That system relates to the millions of transactions that occur daily between banks as cheques are tendered by citizens and firms and more. Without a coherent system of reserves, banks could easily find themselves unable to fund another bank’s demands relating to cheques drawn on customer accounts for example."
My question is then is there any danger for the Fed with having these "liabilities" on it's own books? I mean can these banks actually "default" on their liabilities to the Fed? I don't think so right?!?!
33 comments:
Bank of America down over 4% today, Citi down over 3%, jpm down over 2%....
Maybe how the Fed provided USD liquidity to European institutions in 2008, the US banks will need the ECB to provide Euro liquidity to US banks in 2011...
that's not good.
did you guys notice the nikkei appears to have had a flash crash today. I am not finding any news on it yet...??
Maybe how the Fed provided USD liquidity to European institutions in 2008, the US banks will need the ECB to provide Euro liquidity to US banks in 2011...
interesting...based on the way the ECB seems so reluctant to "bailouts", I wonder if they'd do it.
Fed will, unbelievably, defend LIBOR to the end. For what reason, I have no idea. Why are our banks pricing to LIBOR, anyway?
Does the ECB accept their nation-state debt from banks as collateral at close to par, similar to the Federal Reserve with Treasuries?
TB,
Yes I believe even Greece govt securities are acceptable collateral for ECB open market operations...
I believe the ECB maintains a list of acceptable securities, if a nation's govt debt was to be "kicked off" that list, it perhaps would be the end of the Eurosystem as we now know it.... I think the policymakers over there realize this so they instead make Greece go thru these cathartic austerity measures to give them political cover to keep the Greece govt securities on the list of acceptable securities.... Resp,
Does anyone know if US Money Markets are still exposed to this EuroBank mess?
Anon,
something must be going on there as Mike points out the CDS of the Core nations is now spiking and US banks are getting hit (BofA back under $10) so perhaps these events are related... the problems may this time be coming from Europe...
Resp,
Thanks Matt,
Like you said above and I didn't get. If they have to provide Euro liquidity surely the Euro will fall and the race to the bottom will continue. I wonder if Dr. Bernanke will experiment a little more this time. Is he opposed to a stronger dollar??
"Is he [Ben] opposed to a stronger dollar??"
Yes, it puts the US at an export disadvantage, and the president has said he wants to double exports. That cannot happen with the dollar getting stronger and making US goods more expensive abroad.
So Ben is buying Treas and increasing the Money Supply? I'm not quite sure if there is a slight of hand going on there. I've heard implications that there is some kinda flipping going on between the banks and the Fed. I'm totally at a loss here. And also that MMT says the money supply is really not being increased, which would cause a disconnect it seems between the real strength of the dollar and what is common thought. This kinda fits with my distant past memories of similar situations when the dollar became strong suddenly. Is this a possibility or have the markets got it right and we should expect a continuation of the 'artificial' rise in equities??
Buying tsy's doesn't increase the money supply (in circulation). It increases bank reserves (monetary base). It's just a shift in composition and maturity of non-government saving. It doesn't affect the amount of non-government net financial assets.
I heard one MMT person actually say that money was actually being taken out of circulation. And I have no problem with what you said about the (base) or above either, but doesn't that set up a day of reconing with the 'real' value of the dollar?
Super cool! Many thanks. I'm right now under heavy fire from my German friends for being a traitor to the core of Europe — the good responsible nations. I do not watch the CDS market regularly but from now on I will. Must post this tomorrow in German!
"I heard one MMT person actually say that money was actually being taken out of circulation. And I have no problem with what you said about the (base) or above either, but doesn't that set up a day of reckoning with the 'real' value of the dollar?"
Anonymous, Why would it lead to "a day of reckoning" for the dollar. Do you know something that the bond market don't? They are happy buying 30yr tsys at historically low rates.
Much ado about nothing if you understand how the monetary system works.
Much ado about nothing if you understand how the monetary system works.
wouldn't that be b/c those funds will never see the "light of day" so to speak as they are all reserves anyway? The question about bonds or reserves simply becomes the level of interest paid out...and once there's no other option then there's no other option and that's the end of that. Since when did banks need to get a real return (aka a "free ride") on their reserves in the first place?
There has to be a transmission mechanism from reserves to spending, and this is usually presumed to be the money multiplier. But the money multiplier in normal times was just an ex post accounting record not an ex ante cause. What MMT had been asserting was shown to be the case through QE and paying interest on reserves. The large build up of reserves was unable to create even a slight bit of inflationary pressure, as the Fed had hoped it would.
The transmission mechanism for getting currency into the economy is government expenditure, and the transmission mechanism for the creation of credit money by the private sector is demand for loans by creditworthy borrows. That has not happened.
While excess reserves (monetary base) as gone exponential, M2 has fallen and inflation remained low. But don't worry, the inflationistas assure us, hyperinflation is just around the corner. Really?
If US banks have Euro denominated liabilities that are being called in, and they cannot easily provide the Euros, then US banks I believe would have to sell USDs for Euros which would make the USD go down.
(This is of course all hypothetical at this point) This would be the opposite of what happened in 2008 when Euro banks got called on USD liabilities, they had to sell Euros to get the USD and the USD rallied until the Fed finally went the full monty with the FOREX swaplines.... then the USD rally was stopped cold.
I cant see how US entities could be short Euros anywhere near as much as the Euro intitutions were short USDs back in 2008.... but it could still be a substantial problem for the already stressed US bank balance sheets... and perhaps could put pressure on the USD until the ECB would perhaps step up and provide US institutions whatever Euro liquidity they needed short term.
Resp,
Elastic currency theory - swelling of reserves to stop a run at banks.
Is there anything to show for ...
“I heard one MMT person actually say that money was actually being taken out of circulation. And I have no problem with what you said about the (base) or above either, but doesn't that set up a day of reconing with the 'real' value of the dollar?”
Anon,
On the above questions:
First on money being taken out of circulation because of QE:
This was implied because taking the treasuries out of the market during QE means the interest payments, on those treasuries, are taken out of the market too (the FED refunds its revenues, less its operational expenses, back to Treasury, so those interest payment basically go right back to Treasury after the Treasury makes them.) This means that the private sector will not get those payments on the treasuries that QE bought. Therefore, money supply will be less over time than it would have been.
On day of reckoning:
I assume you mean with the reserve increase that your assumption is that that scenario would lead to more money being lent by banks, therefore money supply could explode via those reserves. This is not correct because bank lending is not reserve constrained – the money multipler is a “myth.” Banks can always make loans, no matter what reserves they have. For example, just by the action of lending past reserve requirement, the Fed charges the bank for a loan. So lenders do not check their reserve capacity before making loans - the only restrain on lending is if the loan will be profitable to the bank after borrowing from the Fed if reserves are already fully taken. So the theory is that banks will make X amount of loans, with the condition being profitable or not to do so, no matter what the size of reserves. So increased reserves will not result in any more or less loans basically.
the only restrain on lending is if the loan will be profitable to the bank after borrowing from the Fed if reserves are already fully taken.
wouldn't the bank's reserves be increased automatically once the new loan was made? Are reserves ever "fully taken"?
Also how does this relate to bank's being required to put money down on their loans they make? Is that the reserves or something else?
Plus if reserves are always there through the Fed, why have them accounted for in the first place? What are they doing exactly for the banks/loans?
Cheers!
Mario,
On “wouldn't the bank's reserves be increased automatically once the new loan was made? Are reserves ever "fully taken"?”
I do not fully understand the accounting. I think the loan deposit, whether with the lending bank or another bank, creates reserves in the “system.” Do they offset? Reserves reduced from the loan but then added back from the deposit? I do not know.
I do not understand the details of the accounting, so I am not sure if this lending would increase reserves for the system as a whole or if it would be horizontal and system wide reserves would stay the same. For example, does the reserve loan to the lending bank by the Fed decrease system-wide reserves but then the customer’s deposit from the bank loan (or a third party’s deposit of those funds if the borrower pays another party with the funds) increases system wide reserves by the same amount and they off-set. Or is the final accounting, the Fed has increased reserves by the amount of the reserve loan to the lending bank? Anyone know?
On “Also how does this relate to bank's being required to put money down on their loans they make? Is that the reserves or something else?”
I do not think banks put down any money. From what I have read from Warren Mosler’s posts on this, I “think” bank loans are made regardless of reserve situation – reserve situation only enters into the decision on cost to make the loan. And the Fed bank loan is straightforward. For example, if a bank is within its reserve requirement, then no loan from the Fed to make the loan to the customer. If the loan would fall outside of the lending bank’s current reserve requirement, then a loan from the Fed automatically happens (bank does not request it or anything, it is just noted by the Fed and interest starts accruing to the bank.) So in the latter case, it would just directly cost the bank more to make the loan to the customer because the bank would have to pay interest to the Fed to meet its reserve requirement via that Fed loan. Mosler implies this could be done to any amount. I guess the only question on limit is if a bank is deemed insolvent and can meet deposit demands or not and then the FDIC would take it over.
Mario,
“Plus if reserves are always there through the Fed, why have them accounted for in the first place? What are they doing exactly for the banks/loans?”
I guess it is just accounting and there is no real limit – just a soft cap via interest rates. The Fed will always give a solvent bank a Fed loan (I am assuming this from reading Mosler and Ed Harrison and Cullen Roche) to meet that bank’s reserve requirements. So, I guess the Fed can only soft-cap lending via the Fed funds rate (jack them up high enough that banks cannot make profitable loans past their reserve requirements and/or force banks to increase rates to customer which would curtail the private sectors desire to borrow. )
Would someone else help us on the exact mechanics of this?
Mario & Crake,
While you both are now more qualified to be Treasury Secretary than Geithner, you should perhaps correspond with JKH or Ramanan on this topic of "reserves".
Reserves are a regulatory construct the way I look at it. Really the only people who should be concerned about Reserves are bank Regulators and if you are the compliance officer in a bank.
Reserve levels dont provide any insight into the economy or economic activity (except for morons). That said, as an academic exercise, suggest try to engage JKH into posting a typical banks balance sheet details and you will see how bank accounting uses the concept of "reserves" to build a bank balance sheet and this may be academically informative for you (and me probably!)
Ill see if I can find any previous posts on reserves and post them here....
Resp,
"On “wouldn't the bank's reserves be increased automatically once the new loan was made? Are reserves ever "fully taken"?”
I do not fully understand the accounting. I think the loan deposit, whether with the lending bank or another bank, creates reserves in the “system.” Do they offset? Reserves reduced from the loan but then added back from the deposit? I do not know."
There are two ways that reserves are created by the Fed, one is Treasury spending, and the other is loaning to banks against collateral.
The excess reserves over required reserves in the system are neutralized by issuance of tsys in offset of the deficit to drain excess reserves to maintain the Fed's target rate if it is not paying a support rate on excess reserves and doesn't want the target rate to fall to zero.
Loans (made against bank capital) create deposits. This creates a reserve requirement corresponding to the deposit size. If the depost is spent outside the bank, then the bank also needs reserves to clear its checks in the interbank market.
Banks get required reserves and reserves for settlement in several ways — through internal operation, interbank exchanges, borrowing from other banks in the interbank market, and also, usually as a last resort by borrowing from the Fed against collateral, generally tsys.
good post (and reference links) from Bill Mitchell on deposits and reserves:
http://bilbo.economicoutlook.net/blog/?p=14620
Matt,
From that link, "They can borrow from each other in the interbank market but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. In these cases, the bank will sell bonds back to the central bank "
Would the above be the basis that QE did nothing as far as money supply potential because the banks could have always posted the bonds that QE bought as collateral for loans from the Fed or sold them outright to the Fed anyway. Therefore QE was completely neutral in money supply potential?
(Note that by money supply potential I mean potential for more loans/added credit in the system.)
Based on
“Does the bank’s reserve fall as a consequence? Not necessarily because it depends on other transactions. What happens if the car dealer also banks with Bank A (the consumer’s bank)? Then Bank A just runs a contra accounting adjustment (debit the borrower’s loan account; credit the car dealer’s cash account) and the reserve balance doesn’t change even though a settlement has taken place.
There are more complicated situations where the reserve balance of Bank A is not implicated. These relate to private wholesale payments systems which come to the settlements system (aka the “clearing house”) at the end of the day and determine a “net position” for each bank. If Bank A has more cheques overall written for it than against it then its net reserve position will be in surplus.”
which is looking at reserves changes from the perspective of one bank, one can assume that bank lending, across the whole system, always cancels, if the money stays in the system. The above example uses one bank, stating that if the proceeds from a loan come back as deposits to that same bank, there is no change in that bank’s reserves. Therefore, I assume if the proceeds go to another bank, then isolating that one loan would mean the lending bank’s reserve go down by the amount of the loan and the other bank that receives the loan proceeds as a deposit has its reserves go up by the same amount, so a system containing both of those banks, sees no change in reserves. Therefore, one can conclude that all bank lending, if the proceeds stay in the system, are horizontal with no change system-wide, right?
But if the proceeds went to buy imports and the proceeds left a system to go to a foreign sector’s system (foreign sector’s central bank holds those proceeds as reserve currency), then it would be a loss of reserves for a system, right? But if that foreign sector left the proceeds in the system of the buyer of its imports (Chinese exporters buy US bonds for example), then again the system would not change?
Do I have this right?
thanks for the comments everyone. I'm very interested in this topic.
I just arrived at my vacation destination for the week (I threw out that question yesterday just before leaving for my plane! LOL).
I'm going to look over this stuff when I can and chime in later on...probably next week.
Cheers!
matt that link is awesome by bill (as usual of course).
There are a number of gems in this one...but this one stuck out to me in regards to this discussion:
"The major insight is that any balance sheet expansion which leaves a bank short of the required reserves may affect the return it can expect on the loan as a consequence of the “penalty” rate the central bank might exact through the discount window. But it will never impede the bank’s capacity to effect the loan in the first place."
So this answers my question as to what is the purpose of reserves anyway...they simply facilitate the interbank market to handle all daily transactions in the economy. It has NOTHING to do with "backing" the loan per say. It has to do more with "accounting for" that loan (new money) in the economy. If the lending bank doesn't do that by increasing their reserves accordingly, then they will likely get penalized for going below the reserve requirement and be forced to use the discount window. It's interesting to note that the Fed put out a paper a while back which I read that discussed how during the GFC most banks decided to rather loan to each other in the interbank market at higher rates than to go to the discount window at the Fed. It seems to be that feared. Interesting indeed.
@crake
it would appear based on what bill is saying that reserve levels grow as more loans are made simply b/c there's more transactions now taking place in the economy, but that is the responsibility of the bank to manage their reserve levels based on the amount of loans they are issuing otherwise if they are under reserved then they will get penalized.
he also seems to state that net reserve levels only increase through vertical transactions (government to non-government), and I am assuming this includes whenever a new loan is made b/c the Fed (government) increases the reserves of a bank (non-government). Check me if I'm wrong. The quote below is referring to interbank lending (non-gov to non-gov) of reserves which does NOT increase net reserve levels for obvious double-entry accounting dynamics.
"We might qualify the statement that banks do not lend reserves. In a sense, they can trade them between themselves on a commercial basis but in doing so cannot increase or reduce the volume of reserves in the system. Only government-non-government transactions (which in MMT are termed vertical transactions) can change the net reserve position. All transactions between non-government entities net to zero (and so cannot alter the volume of overall reserves). I explain that in more detail including the implications of that point in the trilogy of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3. It helps to understand why budget deficits place downward pressure on interest rates – which is contrary to the mainstream macroeconomics textbook depiction captured by “crowding out”."
cool stuff for sure. I also liked that contra-accounting piece you mentioned too Crake. Pretty interesting stuff. Cheers!
this quote from the article Matt linked really clearly explains the sole purpose of reserves. Fascinating, simple, and makes sense to me!! It's incredible just how wrong most economists and professionals have this stuff!!! It's really very practical and functional.
"The commercial banks are required to keep reserve accounts at the central bank. These reserves are liabilities of the central bank and function to ensure the payments (or settlements) system functions smoothly. That system relates to the millions of transactions that occur daily between banks as cheques are tendered by citizens and firms and more. Without a coherent system of reserves, banks could easily find themselves unable to fund another bank’s demands relating to cheques drawn on customer accounts for example."
My question is then is there any danger for the Fed with having these "liabilities" on it's own books? I mean can these banks actually "default" on their liabilities to the Fed? I don't think so right?!?!
Post a Comment