Monthly Archives: January 2012

Why is the Fed paying interest on reserves?

  By Mike | January 30, 2012 - 21:16 | ,
24 Comments

The answer to that question by Eugene Fama in this week’s Econtalk (from 39:28-40:42) struck me as particularly insightful, but I’m not sure I completely understand it.

39:28 Russ: Do you have any thoughts on why the Fed is paying interest on reserves? Guest: Oh, absolutely. Because they know that if there is an opportunity cost from these massive reserves they’ve injected into the system, we are going to have a hyperinflation. Russ: So what’s the point of injecting the reserves if you are going to keep them in the system? Guest: Exactly. Russ: So what’s the answer? Guest: The answer is: this is just posturing. What’s actually happened? That debt is now almost fully interest-bearing, all the liquidity that they’ve injected. So, they’ve actually made the problem of controlling inflation more difficult. Controlling inflation when they didn’t pay any interest focused on the base: cash plus reserves. But now the reserves are interest-bearing, so they play no role in inflation. It all comes to cash, to currency. How do you know? Currency and reserves were completely interchangeable; that’s what the Federal Reserve is all about. So I think they’ve lost it. Now what happened, they went and bought bonds, long-maturing bonds, and issued short-maturing bonds. It’s nothing. They didn’t do anything. Russ: But they are smart people. Guest: Right. Russ: Ben Bernanke is not a fool. If you could get him alone in a quiet place with nobody else listening and say: Ben, what were you thinking? What do you think he’d say? Guest: I don’t know, but I wouldn’t believe it. In the sense that at most he could have thought he could twist the yield curve. Lower the long-term bond rate. Now I’m looking at the long-term bond market–it’s wide open. Even though they are doing big things, they are not that big relative to the size of the market. Russ: Yes, I am mystified by that as well. I don’t have an explanation.

Why is it that, because reserves are interest-bearing, they play no role in inflation? Because they’re not being loaned out into the system? But haven’t we established that banks don’t lend from reserves anyway?

So now he says inflation all comes down to cash, to currency, “because currency and reserves are completely interchangeable; that’s what the Fed is all about.” I don’t get what exactly that means, or why that makes the problem of controlling inflation more difficult.

Clueless

  By Mystic | January 28, 2012 - 12:11 |
7 Comments

It’s easier for the US….Their political battles are mostly internal squabbles over the route of the gravy train.
In Europe things are much more complicated. I’m sure they want to do what is best for Europe as a whole (if only to make the problems go away), but are always drawn back to their domestic imperatives.
They cannot admit defeat over the `Europe problem`, but cannot afford to make the sacrifices necessary to move toward solving it.
The European Union is `home` to 330 million people.
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13:50 min.

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The road once travelled

  By Mystic | January 27, 2012 - 12:15 |
12 Comments

Although non of them have such bad demographics, the rest of the OECD are going to struggle to get off Japan’s path to the `land of zero everything` (from whence no country returns).
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13:09 min.

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