23 July 2012

About Those Excess Reserves At the Fed

"Some men weave their sophistry until their own reason is entangled."

Samuel Johnson

IOER is Interest On Excess Reserves.

The next time some economist says that paying interest on Excess Reserves does not matter, show them this newswire copied below, and let them argue it with Alan Blinder.   San Francisco Fed President John C. Williams made a similar argument about four weeks ago. And Bernanke concurs that this is a powerful weapon in his mad scientist's toolkit.

But then we see pieces in the financial press or on econo-chatboards like this, scornfully dismissing the notion that interest payments on excess reserves matter at all because the excess reserves don't matter.  Base Money Confusion by Izabella Kaminska.

I have even seen the Fed arguing out of both sides of their mouth on this one.  I know there is room for disagreement, but that is just a bit too much. This is like one of those nice little jargon related sophistries that engineers like to use to make annoying marketing managers go away in despair.

I suspect that some economists argue that Fed interest payments on reserve do not matter because they do not want to deal with the political issue of paying what is essentially a subsidy to the banks for the reserves that the Fed creates for them.

And there are plenty  of economists who seem to make whatever argument that the Banks want them to make on any issue on any given day. It seems to be almost a cottage industry at some university economics departments.

Or in some cases it could be that like most money misconceptions, some folks like to get caught up in the details of the thing, putting an inappropriate linear bustier on a dynamic system process, and thereby become mesmerized by 'chicken and egg questions,'  losing sight of the big picture but 'proving' some outlandish theory about how money is created and how the banking system really works.

If reserves do not matter, if they are a meaningless accounting entity, then it would not matter what the Fed pays on them, except for the purposes of a risk free handout to their banking buddies.  And there may be a valuable insight in that after all.

Regardless, I would just like the Fed to make up its collective mind what their position on this really is, and not trot out whatever argument they feel suits the moment, although that does seem to be à la mode amongst economists these days. They have become as bad as attorneys and accountants.  The truth is whatever we say it is, whatever the guy with the most money wants it to be.

This might be a fine question for some astute Congressperson to pin Benny down on for the record the next time he stops by for a chat. I seem to recall the NY Fed dissing a Congressperson on this matter a few years ago when they suggested that paying interest on Bank Reserves was inhibiting the flow of money out of the banking system and into the real economy.

So the next time I get into a discussion on this with some condescending obscurantist from the NY Fed, I am just going to send them this link and let them have at it with Ben, Alan, John and the other Sorcerer's Apprentices of finance who, like Alice's souffletic friend, choose to define reality to suit their changing needs.

08:12 Former Fed Vice Chairman Blinder says Fed should cut IOER -WSJ

Former Fed Vice Chairman Alan Blinder, in an opinion piece, said the Federal Reserve has many weapons left to provide a boost to the economy, but the most powerful tool would be lowering the interest rate on excess reserves (IOER) held by banks.

Blinder said Operation Twist, QE3, and forward guidance are weak weapons that won't be as effective as cutting the IOER to zero, and if nothing goes wrong, to -25bp.

He argues that doing such would provide a powerful incentive for banks to put some of their idle reserves to work, possibly lending it out or putting it in the capital markets.

Fed Chairman Ben Bernanke said last week that the Fed still has a number of tools available should it decide to implement additional stimulus, including its balance sheet, communications strategy, IOER and the discount window.

Postscript: By the way, I do understand how Excess Reserves are created, and why that really is not relevant to the discussion of paying modest interest on them. I can be playful too.

It is more a matter of the Fed taking extreme measures to cover up the rottenness of the assets on the Banks' balance sheets and their real insolvency, whilst providing them the equivalent of monetary food stamps.

The best argument against Blinder's plan is that since the market is already willing to buy short term Treasuries at negative interest rates, why would not paying interest on excess reserves, or even charging a modest amount, cause the banks to reduce their reserves? Especially when they have access to the gaming tables thanks to the repeal of Glass-Steagall. Easy money chases beta.

It *could* drive more short term money into the longer end of the curve which is another one of the Fed's fruitless attempts to provoke the real economy by imitating vitality.

What makes this problem difficult is not that it is some advanced form of maths, but that it is so enshrouded with prevarication, privilege, fraud, and the other trappings of the credibility trap and a self-serving elite who abuse their good fortune and their talents.