Going Broke by Fractions of a Percent
Ben Bernanke should stop paying interest on reserves
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GoogleFederal Reserve Chairman Ben Bernanke’s rollout of $600 billion in quantitative easing was a public relations disaster that deserves to be studied in college communications classes. And he could have avoided it by giving up a shiny monetary tool he got in 2008—one that may be at the root of the extended recession.
The Federal Reserve Bank’s shopping spree of distressed debt will, Bernanke claims, create 700,000 jobs over the next two years. But if one of its immediate goals was to inspire market confidence, Quantitative Easing II (QE2) could hardly have gone worse.
In the three months since Bernanke floated the idea of a second round of large-scale asset purchases, the U.S. dollar index has declined by about 5 percent. With household net worth at $54.6 trillion, according to the Fed’s most recent Flow of Funds data, this means about $2.73 trillion of domestic wealth may have vanished in three months.
While much of that fall took place during the period between Bernanke’s QE2 trial balloon in late August and the rollout of the actual program two weeks ago, events since QE2 actually hit the streets have not been encouraging. German Finance Minister Wolfgang Schaeuble called the move “clueless,” and China’s Dagong Global Credit Rating Co. downgraded long-term U.S. debt. The Anglophone financial press tends to dismiss such criticisms as nationalist trash talk, but QE2 cast a glare over President Barack Obama’s Asia junket and made what would ordinarily be considered an average performance—the president failed to close a trade agreement with South Korea and came home with few solid results—into a demonstration of U.S. powerlessness.
The domestic response has been just as gloomy, but for opposite reasons. While yields on U.S. Treasury debt have ticked up (the yield on the 10-year note has risen 0.23 percent since the beginning of November), at home the problem is that QE2 is not creating the lending boom and subsequent price inflation that Bernanke for nearly two years has been trying to conjure through frenzied rain dances. A survey of currencies pegged to or closely aligned with the dollar reveals pockets of robust inflation, but U.S. economic activity is horizontal at best: Retail activity has picked up a little, while house prices, housing starts and mortgage purchase activity are all dropping.
Even Wall Street failed to respond. After a smaller-than-anticipated post-QE2 rally, the Dow Jones Industrial Average has been sliding steadily, and is now lower than it was a month ago. (Though it’s still 1,000 points above its late-August level, suggesting that whatever market excitement QE2 will arouse has already subsided.)
So quantitative easing (large-scale central bank purchases of public and private debt instruments designed to keep interest rates down and increase the flow of money into the economy) is on the verge of striking out twice. Bernanke’s 2010 is ending pretty much like his 2009, except that he’s unlikely to return as Time magazine’s Person of the Year.
Could he have done things differently?
Yes, he could have. There may be no scenario under which Bernanke’s extremely accommodative monetary policy (one which follows the late Milton Friedman’s recipe) would have made a difference in an environment where a broke populace has no appetite for debt and banks see few credit-worthy lending opportunities.
But he could have been spared some of the humiliation if he’d listened to dissenters (including a growing number within the Fed) and tried some other tool to get banks, as the politicians say, lending again.
To be clear: Bernanke would not have gotten banks lending again. He just would have been spared some shame.
The Fed is two years into an experiment that is new in the central bank’s 97-year history. It is paying banks interest on reserves. According to Fed and independent analysts, interest on reserves is a powerful new tool that allows the Fed to create all the new money implied by QE2, while preventing that money from flooding into the private sector and causing uncontrollable inflation. “We can have an enlarged balance sheet and not have a long-term inflation problem,” New York Fed President William Dudley told CNBC on Tuesday. “This is because we can pay interest on excess reserves, which can moderate credit demand. We did not have this tool before 2008. So if you're reading the old textbooks about money and banking, you would be very concerned.”
Like many bad ideas, interest on reserves originated with Milton Friedman, but it is being applied in a way the great Chicago economist and monetary theorist did not foresee. Friedman advised payment of interest on those reserves banks are required by law to keep. The Fed is paying interest on both required and excess reserves—the latter of which have ballooned in the last 18 months and now stand at about $1 trillion, a level that is unique in U.S. banking history.
Comments like Dudley’s above, backed up by Fed studies [pdf] and both Fed supporters and detractors, suggest interest on reserves (IOR) prompts banks to keep that money locked up in vaults rather than lending it out. If you are getting an interest rate higher than inflation from the Fed, the argument goes, you will keep the money parked where it is.
That raises a simple question: Rather than creating new money through QE2, why not reduce or eliminate the interest on reserves, and let the excess reserves flow out into the economy?
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A two-hour live prime-time discussion among Bernanke, Geithner, and Ron Paul would do wonders.
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Not for Bernanke and Geithner.
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Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.
Ben Bernanke Nov 2002
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This guy's good. You should hire him.
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The Ben Bernank has a nice beard.
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The reason why the Fed wants to keep all those reserves on the bank's balance sheets is because it knows they will be needed to cover the losses from the toxic assets which are still being held by banks at inflated/notional values.
That trillion in excess reserves isn't enough to cover their bad assets.
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Bullseye. (Is there a bullseye emoticon? Cause there should be.)
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Exactly. The reason why they are paying interest on the "excessive" reserves is that they don't beleive they are excessive. My guess is they don't yet even have enough cash to cover all the losses, hence why we are printing more money.
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yes. We are printing money, and GIVING it to the banks. And not just by paying interest on reserve, but by buying up toxic assets as well.
This isn't even loan money. We're just flat out handing free, freshly printed, money to a small, wealthy elite.
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you say that if it were a bad thing.
Our "top men" know that credit is the lifeblood of the economy, and if we don't pump, pump, pump the credit ponzi...uh, fractional reserve banking system...and don't protect and reward our "top bankers" who gave 3/4 of a million dollar loans, to strawberry pickers who make 14K a year, it all goes to poopy.
Sure, the great unwashed think that maybe people who don't understand that loans have to be paid back should be running an economy, but that is just recondite thinking. -
I have a different idea.
I think we should democratize the payment of this interest. ANYONE who keeps cash in the bank should get paid by the federal reserve, not just the banks. -
Hazel Meade|11.18.10 @ 6:01PM|#
"I have a different idea.
I think we should democratize the payment of this interest. ANYONE who keeps cash in the bank should get paid by the federal reserve, not just the banks."This is fine, but Bernanke is doing something else: He's *loaning* money and paying the borrower interest. I'd love to borrow money and have the lender pay me interest.
If 'high-powered money' is M0, this is some weird M0.5. I can't find any sort of precedent, and it looks like Bernanke is doing a bit of OJT on the US economy. -
They want to keep those reserves on the bank balance sheets so they can create money out of thin air, but defer the inevitable massive inflation that will occur as soon as the floodgates open and that money gets dumped into circulation and starts chasing a limited supply of goods and services.
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What pisses me off the most is ...
They want to create money from thin air, and transfer it directly into the private hands of the banks.
That the grotesque injustice of that is barely commented upon by the "liberal" media is almost as appalling.
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I thought it was just a way for the Fed to directly subsize the banks to help them generate revenue.
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That's like saying that I'm paying you welfare to help you generate income.
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Right. If you don't make enough at a job to pay minimal rent and you need an apartment to keep your clothes (and shower) in order to stay presentable and keep your job, then subsidization of your rent would be paying you welfare to help generate income.
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Isn't that the definition of "stimulus"?
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http://www.youtube.com/watch?v=RAFIF0E61GI
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...the problem is that QE2 is not creating the lending boom and subsequent price inflation that Bernanke for nearly two years has been trying to conjure through frenzied rain dances.
How fucking incompetent is your government when they can't even create the inflation they want?
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They're incompetent alright, but not stupid. The key here seems to be that they're trying to cover their tracks - they want to be able to say, when the dollar goes bust, that it wasn't their fault and that it's the banks and other institutions that caused the problem (which, of course, is a lie, but one that they'll put forth anyhow).
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(which, of course, is a lie, but one that they'll put forth anyhow).
And that a lot of suckers will buy.
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20 years of wage inflation?
I agree that there was a housing bubble, but a wage bubble?
Anyway, yes, the interest rate on reserves should fall--slightly less than zero is the right level.
No, this doesn't paper over bad loans. That confuses reserves and capital.
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Tim: there is one sure-fire way to get banks to lend. Inflation. With inflation running at a nominal .6%, the lowest real interest rate you can have is -.6%. This level is not low enough to force banks to lend, or clear the market between lenders and borrowers. At 4% inflation, however, you can have a -4% real interest rate (nominally zero), which pushes everyone to quit sitting on their cash.
Deflation is the problem. Moderate inflation is the solution.
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You call it the problem. I call it a sensation the American people are never under any circumstances allowed by their masters to experience. Even though they cry out for lower prices all the time.
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If it weren't for long-term contracts (like mortgages) a little deflation might not be much of a problem. With deflation, borrowers would be paying back loans with dollars that are worth more than the dollars they were originally lent. That makes default even more appealling, which doesn't seem like a good strategy during a mortgage crisis. Deflation would also make our national debt that much more expensive.
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Still looking for the downside, gk.
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Also, the graf about internal governance at the Fed is strictly my own speculation. No research or interviews for this article suggested the BOGs' setting of the IOR rate created a conflict with the FOMC, the RBGs, the FBI or the BMOC.
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The printing press is nothing more than redistribution from the non financial sector to the financial sector. The bank "pays interest" by printing more (ripping off consumers). When new money is printed, all consumers should be sent a rebate check for their share of newly printed money. The newly printed money should not be given to banks (interest on reserves).
Better yet, just stop printing. Confiscating purchasing power for redistribution by the central planning committee (open market committee) makes no sense. Central planning does not work, including central planning of interest rates and the CPI.
Serial bubbles, credit crises, and a lower standard of living for the non financial sector are the results of printing. Not to mention capital mis-allocation (rows of empty McMansions) caused by printing. The central planners at the central bank just do not know what they are doing.
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