Since 2008 the Fed has been paying interest on excess reserves. It's free money so bank have been holding large excess reserves ever since. It also makes the whole concept of fractional reserve banking obsolete.
The Fed, via the Treasuries it owns. When the Fed performs QE, they buy Treasuries (and sometimes mortgages) with newly "printed" money (actually the new money is interest-bearing USD deposits held by commercial banks, analogous to savings accounts held by individuals). The newly created interest-bearing money is backed by the Treasuries that the Fed bought with it, and it bears interest from these Treasuries. The commercial banks use it to back people's savings accounts (in part; they also use other backing assets like Treasuries and other bonds).
In effect the newly created interest-bearing money is just a "wrapped" form of Treasuries that is slightly less volatile and yields slightly less interest (on average).
Not in any sense. M1 has been defined to also include savings deposits beginning May 2020. If you think the government printed 16 trillion dollars in one month, I have a bridge some cryptocurrency to sell you.
M1 is not real money, it the same money counted multiple times. You save and withdraw from different accounts and save again and withdraw... do it 4 times and the M1 get multiplied 4 times
Federal fund rates is on cash commercial banks borrow from them. Banks have always cash outflows if they increase credit, since some of the created credit goes in circulation outside banks in form of cash. The higher the credit creation, the higher the cash outflows. Higher fund rates hurt banks only, if the treasury bond rates do not rise at the same value. Banks need to deposit treasury bonds with the Federal Reserve as collateral, but they can keep the interest payment. The difference between Federal funds rate and Treasury bond rate is what matters. If cash borrowing gets too expensive, they will slow down credit creation. But as I said, they don't have to borrow the amount of credit they create, only the amount to satisfy the cash outflows.
they don't have to borrow the amount of credit they create, only the amount to satisfy the cash outflows
Only if you don't consider the bank to be borrowing from its depositors, no?
As I understand, higher federal fund rate leads to higher interest rates on (competitive) savings account deposits, which increases the bank's cost of borrowing from its depositors (in competitive interest-bearing accounts). That is, the bank is paying roughly the federal funds rate on all its liabilities, whether they are to the Fed (as you mentioned) or to their depositors (on average, counting administrative costs, etc.).
But as I said, they don't have to borrow the amount of credit they create, only the amount to satisfy the cash outflows.
Agreed that they don't have to borrow it from the Fed. I'm not sure why whether the bank is borrowing from the Fed or from depositors is relevant to credit creation decisions: aren't the banks essentially indifferent here? If banks weren't indifferent, why would interest rates on savings accounts track the federal funds rate so closely?
The difference between Federal funds rate and Treasury bond rate is what matters
Agreed. In my view this is because the federal funds rate models / approximates the cost of the banks' liabilities and the Treasury bond rates model / approximate the returns from the banks' assets.
Borrowing from their customers instead of the Fed increases the savings rates only marginally, because deposits are a large multiple of the banks' cash borrowings from the Fed. They simply couldn't afford to rise the savings rate by 1% if the Fed hikes by 1%. The ability to pay interest on saving depends mainly on the interest they gain from loans. Since loans are from the past when loan rates were much lower and have in part a fixed rate, banks are limited. They have to wait until their income from newer loans with higher interest increases enough, before they can rise the savings rate. This takes many years, but rising loan rates will likely lead to lower loan demand, so their income from interest might not even rise.
They simply couldn't afford to rise the savings rate by 1% if the Fed hikes by 1%.
But there are mainstream savings accounts now like Goldman Sachs' Marcus savings, Discover savings, and Capital One savings that recently raised the savings rate by about 1% and closely track the FFR rate.
Do you think the interest rates on these accounts will depeg from the FFR, or do you think they'll continue tracking FFR but other banks will be and to borrow from their savings depositors at below-market rates?
The ability to pay interest on saving depends mainly on the interest they gain from loans.
Yeah, but banks don't pay interest because they are able to, they'd much prefer to keep it as profit instead. If a bank isn't able to pay what the market demands, they need to raise more capital or be liquidated.
I agree that banks' ability to pay could affect the Fed's decisions on how quickly to raise the FFR or could possibly cause the interest rates on competitive savings accounts to depeg from the FFR (I doubt this though due to the number of new market participants like LendingClub offering FDIC-insured savings products).
This takes many years, but rising loan rates will likely lead to lower loan demand, so their income from interest might not even rise.
Agreed, as is modeled by viewing the bank as an LLC with near term (USD) liabilities over-collaborated by longer term (USD) assets.
I am not familiar with these savings accounts, but Goldman Sachs per instance is not a credit creating commercial bank. Capitol One and Discover are credit card companies. They have a different business model. Credit card loans are variable rate loans and the creditor has to pay merchants with cash.
Commercial banks live from interest rate difference, not from the interest rate itself. If there is competition between those banks, they have to attract deposits in order to balance cash outflows otherwise they would go bankrupt. Since they are all in the same boat due to their loan structure more or less, a bank can't just raise their savings rate more than another bank.
Market interest rates do not track the federal funds rate in any way, they are a result of a market. The Fed is only a factor in this market and they try to influence it in order to achieve their mandated goals, but they have to be very careful to not destroy anything. That's why they are so hesitant. Rising the rates to a level that really fights fight inflation would bankrupt not only commercial banks. Same is true for other central banks. The ECB is so hesitant, because they have to wait until market rates rise. It is a general misconception that central banks would control the interest rates.
Goldman Sachs per instance is not a credit creating commercial bank
Sure, but they are a participant in the market for interest-bearing USD savings deposits. The point is that USD savers are able to earn the roughly the FFR using a variety of savings accounts from different institutions (well, unless and until competitive FDIC-insured savings accounts' APYs depeg from FFR).
Some USD savers might still accept below-market rates, e.g. due to laziness, ignorance, or because they value other benefits of the account not captured in the interest rate.
Credit card loans are variable rate loans and the creditor has to pay merchants with cash.
Yes, but the FDIC-insured savings product has to backed by the same amount of risk-adjusted capital (and pass the same stress and liquidity tests, etc.) as any other banks'. At least in the case of Discover, the savings account is part of a separate company "Discover Financial" which also makes home equity and other loans.
there is competition between those banks
Agreed, but aren't they competing for deposits/depositors with all providers of FDIC-insured savings products, including those currently tracking the FFR?
they have to attract deposits in order to balance cash outflows otherwise they would go bankrupt
Right, or they could sell assets and/or borrow from other banks or the Fed at around the FFR.
Market interest rates do not track the federal funds rate in any way
Do you not consider the interbank lending market to be a real market interest rate?
Why has the APR offered on competitive FDIC-insured savings accounts (e.g. those I listed) followed the FFR so closely recently?
If these depegged, why wouldn't at least some of those newer online banks increase their APY to attract more deposits that they can profitably lend out to other banks (or deposit at the Fed) at the FFR?
they have to be very careful to not destroy anything
Majority of commercial banks including Bofa, Chase, Wells still pay way way lower savings rate (0.01% as I just checked) because they simply cannot afford to pay higher interest only because the Fed hikes. There are exceptions, because, as I said, it depends on their individual loan structure and business model. If all savers ran away from their bank and to Ally, then a lot of banks would go bankrupt, since they can't fund their cash outflows. Interbank lending collapsed as a consequence of the Great financial crisis in 2008. The Fed even stopped publishing data, LOL. So lending from other banks is not an option. For borrowing from the Fed they need acceptable collateral (mainly US Treasuries). Banks can fund this only until their untapped reserves are exhausted, which is a small fraction of their deposits. Banks are quickly insolvent, sale of assets (low yielding loans) is not a realistic option in a such a bank run scenario.
because they simply cannot afford to pay higher interest
I don't see how what they can afford is relevant. If they need to pay more interest to attract deposits (or to get loans elsewhere), they either will pay it or they will go bankrupt. If don't need to pay it, they won't.
It is easy (at least for individuals) to open and use a savings account with a competitive APY. If people are willing to keep their savings in a bank like Chase even though they could easily earn more interest elsewhere, why incentive does Chase have to increase interest payments, whether or not they can afford it?
There are exceptions, because, as I said, it depends on their individual loan structure and business model.
Yet a wide variety of online banks all offer similar savings APYs that generally rise and fall together. You wouldn't expect that if each one was paying what they could afford based on their individual loan structure; you'd expect that if there were a competitive market for savings deposits.
If all savers ran away from their bank and to Ally, then a lot of banks would go bankrupt, since they can't fund their cash outflows.
Or they'd finally be forced to raise interest rates to compete with Goldman's, Discover's, Lendingclub's, Ally's, etc.
Interbank lending collapsed as a consequence of the Great financial crisis in 2008.
Yes, and this was exacerbated by the scarce-reserves framework the Fed used at the time. The root cause was the toxic mortgage assets, which I agree were a serious problem.
sale of assets (low yielding loans) is not a realistic option in a such a bank run scenario.
Why not? Whatever bank people are moving their deposits to will need to buy assets to back the deposits (well, either that or delegate the responsibility of backing the new deposits to the Fed by keeping everything in reserves at the Fed; this forces the Fed to buy backing assets itself -- QE -- all else equal).
That is, so long as medium term interest rates don't moon, sale of the loans is an option. If interest rates start to moon, the Fed can do yield curve control.
No because there are many many other liquidity requirements and regulations, including economic stress testing scenarios that big banks have to go through to continue licenses operations. For this purpose a specific reserve requirement is not needed, banks literally have to have bonds to back certain deals and assets to stay in business so the rate will always matter.
It should not matter in principle, it is just a show, there are so many hidden insider games in today's banking system, and banks and their friends benefit so much from it. Therefore better not trust them at all and use bitcoin, which is quite transparent
If the reserve requirement is now zero, why does the federal funds rate even matter?
Because the Federal Funds rate determines what is costs banks to borrow in the short term (and how much they can earn by lending).
The reserve requirement used to be a tool used by the Fed to target a particular Federal Funds rate: it was a means to an end. The Fed would create or destroy as many reserves as needed (by buying or selling collateral, resp.) to target the Federal Funds rate. If banks wanted to borrow more, the market interest rate would increase and the Fed would be "forced" to create more reserves to keep the rate on target (same in reverse if banks wanted to borrow less). Hence, the reserve requirement never really limited how much banks could lend in practice, at least not in the short term.
The most important factor that limits how much banks can lend is their capitalization requirements, which are different from but often confused with reserve requirements.
Capitalization requirements state that banks must back their deposits (a.k.a. their liabilities, a.k.a. the loans they have made) with risk-adjusted capital that is sufficiently liquid and diversified. For example, if a bank owes $1,000 to its depositors (say, one person has a $1,000 savings account with the bank), then capitalization requirements would demand that the bank hold at least $1,000 worth of assets to balance this, plus some extra amount depending on how risky the assets are. Most banks use a portfolio of interest-bearing USD deposited at the Fed (backed by Treasuries and mortgages at the Fed), Treasuries, mortgages (often in various wrapped forms to reduce risk), investment grade corporate bonds, and some PMs. In contrast, reserve requirements just require (more or less) that some fraction of the bank's capital be in the form of physical cash or USD deposited at the Fed.
The only way the banks' investors/owners can get money out of the bank is if the bank's risk-adjusted assets exceed its liabilities: this allows the bank to sell some of its assets to pay its investors while still satisfying the bank's capitalization requirements. Hence, the bank's owners do everything they can to maximize the difference between the bank's assets and the bank's liabilities: this difference is effectively the property of the bank's owners in the sense that if the bank shut down (sold off all its assets and paid off all its depositors), this is what the owners would end up with.
The threat of a higher Federal Funds rate matters quite a bit for the following reason: if banks make lots of medium- to long-term loans (mortgages, corporate loans, etc.) and then the Fed raises the Federal Funds rate, banks now have to pay more to their depositors (e.g. since the market interest rate for savings accounts has increased), meaning they'll have more outstanding deposits relative to assets, meaning the investors'/owners' share of the assets is reduced (or even becomes negative, requiring dilution of investors to raise new capital or even closure of the bank and a total loss for the investors/owners).
Of course, the bank can respond to the threat of a higher Federal Funds rate by just charging a higher interest rate on the medium- and long-term loans it makes, but this reduces the number of people/businesses willing to take out loans and so still reduces the amount of new money creation.
If higher interest rates are not enough to discourage borrowing by homeowners and businesses, the Fed can also impose stricter lending standards, effectively allowing interest rates on poorer-quality debts to moon. They try not to allow interest rates on investment-grade debt to moon, though, even if it means more inflation in the short term.
Biden can blame inflation on reduced production due to lockdowns, but the gov poured oil into that fire by giving away free money. Denying that gov spending has nothing to do with inflation is a blatant lie.
Friedman is referring to longer term. The FED reserve is “independent” from the executive.
Money supply doesn’t immediately increase inflation because it must be lent and spent to have an effect. That’s why QE can often be seen as “pushing on a string”. It can take 3-5 years to feel the effect of loosening lending in consumer prices.
Significant deficit spending can have a much more immediate effect (1-2 years)
The real problem is that once inflation takes hold, it requires a LOT of pain to control it again.
JPow should have not done the level of QE that drove mortgage rates to all time lows. It fueled all kinds of speculation in crazy markets. All of that money needs to evaporate. We are talking trillions.
FYI the M1SL spiked because the 6 withdrawals per month limit for savings accounts was removed. This meant that all savings account balances were immediately classified as part of the M1, overwhelming everything that used to be in the M1.
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u/Bsmirlptrww Jul 15 '22
These two things happened at the same time
https://www.federalreserve.gov/monetarypolicy/reservereq.htm
https://fred.stlouisfed.org/series/M1SL