Wednesday, December 11, 2013

Blinder's Blunder

In a WSJ Op-Ed today, former Fed Vice-Chairman Alan Blinder writes that the Fed should cut the interest it pays on excess reserves so that banks will have more incentive to lend them out:  

"At this point, you're probably thinking: 'Wait. If the Fed charged banks rather than paid them, wouldn't bankers shun excess reserves?' Yes, and that's precisely the point. Excess reserves sitting idle in banks' accounts at the Fed do nothing to boost the economy. We want banks to use the money."

The topic was discussed at the Fed's most recent meeting, as noted by the minutes:

"...most participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage, although the benefits of such a step were generally seen as likely to be small except possibly as a signal of policy intentions." 

Blinder's idea sounds good - but it's based on a misunderstanding.  The presence of so many excess reserves is an accounting by-product of the Fed's asset purchases; it tells us virtually nothing about the state of bank lending or whether banks are "us[ing] the money". This identity was nicely described by NY Fed researchers Todd Keister and Jamie McAndrews in a 2009 paper.  

Lets hope the current FOMC understands how this works.  

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