Saturday, August 27, 2011

Bernanke's Reason for Paying Banks Not to Make Loans

I was reading Steven Williamson's opinion on Bernanke's recent Jackson Hole speech. In it, he said that the only way the Fed can implement policy is by manipulating the interest rate paid on reserves. Williamson then said that Bernanke's speech last year explained why that wouldn't happen.

It is really pretty shocking.

Moreover, such an action could disrupt some key financial markets and institutions. Importantly for the Fed's purposes, a further reduction in very short-term interest rates could lead short-term money markets such as the federal funds market to become much less liquid, as near-zero returns might induce many participants and market-makers to exit. In normal times the Fed relies heavily on a well-functioning federal funds market to implement monetary policy, so we would want to be careful not to do permanent damage to that market.

So, the reason for interest on reserves is to allow brokers on the Federal Funds market to make money and stay in business. The Fed's excuse for keeping these folks in business is to make sure that they are there to help to Fed use its preferred operating procedure after economic conditions return to the way they were in the past.

The Fed wants to do things in familiar ways, and so it is making sure that there is plenty of business for certain money market brokers on Wall Street.

In my view, if banks don't want to do as much interbank lending and borrowing, then brokers in that market should shift to doing other sorts of money market transactions. And then, if interbank lending markets pick back up, then they should shift back. The Fed shouldn't try to keep interest rates up to protect their friends.

If the Fed believes that federal funds are not liquid enough for the federal funds rate to mean much, then the Fed should quit using the federal funds rate as a target.

Or, of course, it could give up on interest rate targeting.


  1. Bill,

    Looking forward to your post where you critique Williamson's claim that QE won't work.

  2. The short-end of the yield curve (the money market), is already INVERTED based upon the remuneration rate (policy rate). .25% currently exceeds the "Daily Treasury Yield Curve Rates" for 2 year governments.

    John Maynard Keynes didn't understand that the deposit-taking, money creating, financial institutions (DFIs) don't loan out existing savings. That's why policy makers eliminated all REG Q CEILINGs. They did this even though the non-banks don't compete with the CBs (from a System's standpoint).

    The fallout is that IOeRs are contractive by design; the principal cause of dis-intermediation (an outflow of funds from the non-banks), which induces debt deflation.

    IOeRs stop (or retard), the flow of savings into real-investment. The higher the rates paid, the slower the money velocity, the greater the deceleration in gDp.

  3. The main concern of administration is to see whether the allow searching for company has uprightness of reaching preferred outcomes are not. When the allow is granted, the company need to demonstrate their success and how they're using the allow money.

  4. Your blogs are totally worth giving time and energy.

  5. I’m surely coming again to read these articles and blogs
    fast pay day loan

  6. It’s really hard to judge things on their speech alone, so we need to look other stuff careful and make sure we have proper plan upfront before we go into any trade. I never worry about it because I have it all covered and that’s thanks to OctaFX broker with their rebate program where I get 50% back on all trading orders which is even with the losing trades, so works so nicely for me and brings a lot of rewards as well.

  7. The last option for credit card debt relief could be the possibility of filing for bankruptcy. If you have filed bankruptcy, you need not pay back your debts because you are declared insolvent. Debt relief