As Dr. Milton Friedman posited; From Carol A. Ledenham’s Hoover Institution archives: “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.
Hi Warren Nice to see you around. Remember our trip to Gaza and meeting w Arafat. This issue also interest me a lot. Why did they propose all out payment of interest on all reserves in 2009 (?)? Has led to huge losses at the Fed, ref. Kupiec’s paper. Will write something on this in the fall. All the v best. Thorvald
Right. It lead to the disintermediation of the nonbanks, where the nonbanks shrank by 6.2 trillion dollars while the banks expanded by 3.6 trillion dollars.
I have some confusion about what is called “ample reserves” since according to papers and articles from the NY Fed the “ample-reserves regime” is placed in the middle of the “scarce-reserve regime” and the “abundant-reserve regime” so it seems closer to a corridor system than to a ceiling system. Where can I find information where these concepts are clarified or defined?
Unlike Treasury issuance, because the belligerent bifurcation (the mis-aligned distribution of sales and purchases of debt by the FRB-NY’s trading desk and its customers/counter-parties is largely unpredictable, so too now is the volume and rate of expansion in the money stock. FOMC policy has now been capriciously undermined by turning excess reserves into bank earning assets. Interbank demand deposits were non-earning assets prior to October 2008. So, the FED has emasculated its "open market power", the power to create new money and credit.
This is in direct contrast to targeting: *RPDs* using non-borrowed reserves as its operating method (predating Paul Volcker’s October 6, 1979 pronouncement on the *Saturday before Columbus Day*), as Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), described in his 3rd edition of “Open Market Operations” published in 1974.
This adds up to an obdurate apparatus that the Fed cannot monitor, much less control, even on a month-to-month basis. What the net expansion of the money stock will be, as a consequence of any given addition or subtraction in Federal Reserve Bank credit, nobody can forecast until long after the fact.
Not sure I understand why parking money at the fed and investing it in t bills is a wash. The amount of interest paid in t bills won't increase, just because more institutions want to buy them?
Tbills exchanged for long term bonds and Fed selling tbills to drain reserves - thats would reduce duration & accelerate payments by Treasury to investors. Funding pressure on government?
Great piece! I'm not sure I agree with your conclusion.
1.)
'' For a given level of liquidity demand, banks would simply shift from holding reserve balances to holding Treasury bills (T-bills) if reserves no longer earned interest. The payments from the federal government to banks would continue, just in the form of interest on T-bills rather than interest on reserves. ''
----> in the above, you're assuming that TBill issuance replaces Reserve balances. In reality, TBill issuance is capped at a certain amount that is determined by the size of the deficit. The interest amount paid via TBills in totality by the federal government would surely remain unchanged in your scenario??
2.)
----> The ideal form of implementation of Cruz's idea is to 'tax' banks with both higher reserve requirements AND zero-interest reserves.
----> This is discussed by the St Louis Fed below:
From the paper: “If the government wishes to fund large real deficits, that will be easier to do if the government eliminates the payment of interest on reserves. This potential policy change implies a major shock to the profits of the banking system.’’ ‘’As such, it is quite possible that a fiscal dominance episode in the US would result in not only the end of the policy of paying interest on reserves, but also a return to requiring banks to hold a large fraction of their deposit liabilities as zero-interest reserves.”
Yeah, saw that. The error is that Friedman called excess reserves a tax rather than "Manna from Heaven".
A brief “run down” will indicate just how costless, indeed how profitable – to the participants, is the creation of new money (not a tax at all). If the Fed puts through buy orders in the open market, the Federal Reserve Banks acquire earning assets by creating new inter-bank demand deposits. The U.S. Treasury recaptures about 98% of the net income from these assets. The commercial banks acquire “free” legal reserves, yet the bankers complained that they didn't earn any interest on their balances in the Federal Reserve Banks.
On the basis of these newly acquired free reserves, the commercial banks created a multiple volume of credit & money. And, through this money, they acquired a concomitant volume of additional earnings assets. How much was this multiple expansion of money, credit, & bank earning assets? Thanks to fractional reserve banking (an essential characteristic of commercial banking) for every dollar of legal reserves pumped into the member banks by the Fed, the banking system acquired about 93 (c. 2006), dollars in earning assets through credit creation.
See: “Bank Reserves and Loans: The Fed Is Pushing On A String” - Charles Hugh Smith
Well done Milton Friedman‘s original proposal was to pay interest on required reserves, but not on excess reserves
As Dr. Milton Friedman posited; From Carol A. Ledenham’s Hoover Institution archives: “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.
Hi Warren Nice to see you around. Remember our trip to Gaza and meeting w Arafat. This issue also interest me a lot. Why did they propose all out payment of interest on all reserves in 2009 (?)? Has led to huge losses at the Fed, ref. Kupiec’s paper. Will write something on this in the fall. All the v best. Thorvald
Right. It lead to the disintermediation of the nonbanks, where the nonbanks shrank by 6.2 trillion dollars while the banks expanded by 3.6 trillion dollars.
how could I forget. send me your email (Wcoats@gmail.com) and I will send you a picture of our meeting with Arafat.
Thvmoe@gmail.com
I have some confusion about what is called “ample reserves” since according to papers and articles from the NY Fed the “ample-reserves regime” is placed in the middle of the “scarce-reserve regime” and the “abundant-reserve regime” so it seems closer to a corridor system than to a ceiling system. Where can I find information where these concepts are clarified or defined?
We are a few geeks who love to study the plumbing of central bank operations.
Cruz is spot on. The entire system has been bastardized. The banks now pay for the deposits that they already own.
Unlike Treasury issuance, because the belligerent bifurcation (the mis-aligned distribution of sales and purchases of debt by the FRB-NY’s trading desk and its customers/counter-parties is largely unpredictable, so too now is the volume and rate of expansion in the money stock. FOMC policy has now been capriciously undermined by turning excess reserves into bank earning assets. Interbank demand deposits were non-earning assets prior to October 2008. So, the FED has emasculated its "open market power", the power to create new money and credit.
This is in direct contrast to targeting: *RPDs* using non-borrowed reserves as its operating method (predating Paul Volcker’s October 6, 1979 pronouncement on the *Saturday before Columbus Day*), as Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), described in his 3rd edition of “Open Market Operations” published in 1974.
This adds up to an obdurate apparatus that the Fed cannot monitor, much less control, even on a month-to-month basis. What the net expansion of the money stock will be, as a consequence of any given addition or subtraction in Federal Reserve Bank credit, nobody can forecast until long after the fact.
https://open.substack.com/pub/johnhcochrane/p/interest-on-reserves?r=1z5qli&utm_medium=ios
Not sure I understand why parking money at the fed and investing it in t bills is a wash. The amount of interest paid in t bills won't increase, just because more institutions want to buy them?
It's not a wash. It could only be considered a wash if the counterparty was only a bank.
Tbills exchanged for long term bonds and Fed selling tbills to drain reserves - thats would reduce duration & accelerate payments by Treasury to investors. Funding pressure on government?
Great piece! I'm not sure I agree with your conclusion.
1.)
'' For a given level of liquidity demand, banks would simply shift from holding reserve balances to holding Treasury bills (T-bills) if reserves no longer earned interest. The payments from the federal government to banks would continue, just in the form of interest on T-bills rather than interest on reserves. ''
----> in the above, you're assuming that TBill issuance replaces Reserve balances. In reality, TBill issuance is capped at a certain amount that is determined by the size of the deficit. The interest amount paid via TBills in totality by the federal government would surely remain unchanged in your scenario??
2.)
----> The ideal form of implementation of Cruz's idea is to 'tax' banks with both higher reserve requirements AND zero-interest reserves.
----> This is discussed by the St Louis Fed below:
https://files.stlouisfed.org/files/htdocs/publications/review/2023/06/02/fiscal-dominance-and-the-return-of-zero-interest-bank-reserve-requirements.pdf
From the paper: “If the government wishes to fund large real deficits, that will be easier to do if the government eliminates the payment of interest on reserves. This potential policy change implies a major shock to the profits of the banking system.’’ ‘’As such, it is quite possible that a fiscal dominance episode in the US would result in not only the end of the policy of paying interest on reserves, but also a return to requiring banks to hold a large fraction of their deposit liabilities as zero-interest reserves.”
Yeah, saw that. The error is that Friedman called excess reserves a tax rather than "Manna from Heaven".
A brief “run down” will indicate just how costless, indeed how profitable – to the participants, is the creation of new money (not a tax at all). If the Fed puts through buy orders in the open market, the Federal Reserve Banks acquire earning assets by creating new inter-bank demand deposits. The U.S. Treasury recaptures about 98% of the net income from these assets. The commercial banks acquire “free” legal reserves, yet the bankers complained that they didn't earn any interest on their balances in the Federal Reserve Banks.
On the basis of these newly acquired free reserves, the commercial banks created a multiple volume of credit & money. And, through this money, they acquired a concomitant volume of additional earnings assets. How much was this multiple expansion of money, credit, & bank earning assets? Thanks to fractional reserve banking (an essential characteristic of commercial banking) for every dollar of legal reserves pumped into the member banks by the Fed, the banking system acquired about 93 (c. 2006), dollars in earning assets through credit creation.
See: “Bank Reserves and Loans: The Fed Is Pushing On A String” - Charles Hugh Smith