This time is different. Well, maybe it really is ...
As people like me have been warning of a great inflation resulting from the Fed's doubling of the money supply, the Fed has been saying, basically, "wait, this time is different, no really it is!"
So what is different this time?
Back during October 2008 the Federal Reserve began paying interest on bank reserves. From its creation in 1913 the Federal Reserve required banks to keep a percentage of their deposits on reserve, but banks were not paid anything to keep these reserves. Having a pile of backup money in the vault was considered a cost of doing business. Having a pile of backup money was what kept a bank from failing.
Well, our pseudo-libertarian friends at the Fed decided that forcing banks to keep reserves was a tax, and that such a tax (like all taxes) is bad for the economy because it distorts free-market decision making ;-) So, the Fed started paying banks interest on their reserves.
This means, essentially, the Fed started paying banks to keep their reserves in a vault, instead of lending them out.
At the time I wasn't sure what effect this would have. Perhaps nobody could be sure, but the Fed pointed to other central banks who already do this and figured it wouldn't hurt.
Rather coincidentally, the current recession started getting much worse in October 2008, and has lasted much longer than most economists expected. And the recession still ain't over, though many of us hope it will end within the next few months.
Could it be that by paying interest on bank reserves, the Fed has effectively removed all these bank reserves from the money supply? If banks are receiving interest on their reserves, then banks don't actually hold cash in reserve, instead they hold interest-bearing debts of the Fed in reserve. At the very least, by paying interest on reserves the velocity of these reserves will fall, and a fall in money velocity is just as powerful as a fall in money supply.
Maybe this discontinuity has thrown all our economic models out the window, and is a primary reason for the deepening, continuing recession. Instead of doubling the money supply over the past year, the Fed actually blew a hole in it.
Well, I guess only time will tell. But the Fed could've picked a different time to experiment with something as basic to our well-being as the velocity and supply of money.
So what is different this time?
Back during October 2008 the Federal Reserve began paying interest on bank reserves. From its creation in 1913 the Federal Reserve required banks to keep a percentage of their deposits on reserve, but banks were not paid anything to keep these reserves. Having a pile of backup money in the vault was considered a cost of doing business. Having a pile of backup money was what kept a bank from failing.
Well, our pseudo-libertarian friends at the Fed decided that forcing banks to keep reserves was a tax, and that such a tax (like all taxes) is bad for the economy because it distorts free-market decision making ;-) So, the Fed started paying banks interest on their reserves.
This means, essentially, the Fed started paying banks to keep their reserves in a vault, instead of lending them out.
At the time I wasn't sure what effect this would have. Perhaps nobody could be sure, but the Fed pointed to other central banks who already do this and figured it wouldn't hurt.
Rather coincidentally, the current recession started getting much worse in October 2008, and has lasted much longer than most economists expected. And the recession still ain't over, though many of us hope it will end within the next few months.
Could it be that by paying interest on bank reserves, the Fed has effectively removed all these bank reserves from the money supply? If banks are receiving interest on their reserves, then banks don't actually hold cash in reserve, instead they hold interest-bearing debts of the Fed in reserve. At the very least, by paying interest on reserves the velocity of these reserves will fall, and a fall in money velocity is just as powerful as a fall in money supply.
Maybe this discontinuity has thrown all our economic models out the window, and is a primary reason for the deepening, continuing recession. Instead of doubling the money supply over the past year, the Fed actually blew a hole in it.
Well, I guess only time will tell. But the Fed could've picked a different time to experiment with something as basic to our well-being as the velocity and supply of money.