Has the Fed Been Breaking the Law?

Federal Reserve, Breaking the Law, the Fed, IOR, interest on reserves, Janet Yellen, Board of Governors, Lael Brainard, Stanley Fischer, Jerome Powell, IOR, Board of Governors, fed funds rate, ffr, Janet Yellen, Hensarling, Huizenga
Group photo after swearing in of Governor Powell, Chair Yellen, Governor Lael Brainard, and Vice Chairman Stanley Fischer. (https://www.flickr.com/photos/federalreserve/14435366834/in/album-72157645246881113/)

Federal Reserve, Breaking the Law, the Fed, IOR, interest on reserves, Janet Yellen, Board of Governors, Lael Brainard, Stanley Fischer, Jerome Powell, IOR, Board of Governors, fed funds rate, ffr, Janet Yellen, Hensarling, HuizengaNo, I don't mean sections 8 and 10 of the Constitution's first article — though goodness knows a case can be made (and has been made recently, and most eloquently, by CMFA Adjunct Scholar Dick Timberlake), that it hasn't adhered to the letter of that law, either. I'm referring to the law authorizing the Fed to pay interest on depository institutions' reserve balances, or IOR, for short.

You see, according to Title II of the 2006 "Financial Services Regulatory Relief Act" — that law that originally granted the Fed authority, commencing October 1, 2011, to begin paying IOR — the Fed is allowed to pay interest, not at any old rate it chooses, but "at a rate or rates not to exceed the general level of short-term interest rates."

As the name of the 2006 Act suggests, its purpose was to relieve financial institutions of unnecessary regulatory burdens. The fact that depository institutions' reserve balances at the Fed, including minimum balances they were required to hold, bore no interest, had long been regarded as one such unnecessary burden. So long as reserve balances paid no interest, reserve requirements amounted to a distortionary tax on bank deposits subject to them. In the words of then Fed Governor Donald Kohn, who testified in favor of IOR back in 2004, the payment of interest on reserves, and on required reserves especially, would result in improvements in efficiency that "should eventually be passed through to bank borrowers and depositors."

Since the original intent of IOR was to remove an implicit tax on deposits, and not to have the Fed subsidize those deposits, it's easy to understand the law's insistence that the Fed pay IOR only at "a rate or rates not to exceed the general level of short-term interest rates." It also easy to see why most economists, including the Fed's own experts, treat the federal funds rate as an appropriate proxy for the opportunity cost of reserve holding, and hence as one of the short-term rates that the rate of interest on bank reserves ought "not to exceed." Indeed, because overnight lending involves some risk and transactions costs, while banks would earn IOR effortlessly and without bearing any risk, the IOR rate should logically be strictly below, rather than below or equal to, the federal funds rate.

Fast forward to 2008. Among its other provisions, the "Emergency Economic Stabilization Act" passed on October 3rd of that year "accelerated" the Fed's authority to pay interest on bank reserves, making that authority effective as of the new law's passage, instead of as of October 1 of 2011. Significantly, the 2008 measure did not otherwise alter the language of the original legislation. The rush to implement IOR was, nevertheless, based on motives quite different from those that informed the 2006 Act. As then-Chairman Ben Bernanke explained, in  an October 7th, 2008 speech he gave at the annual meeting of the National Association for Business Economics, in the wake of  Lehman's failure, the extent of the Fed's emergency lending

had begun to run ahead of our ability to absorb excess reserves* held by the banking system, leading the effective funds rate, on many days, to fall below the target set by the Federal Open Market Committee. This problem has largely been addressed by a provision of the legislation the Congress passed last week, which gives the Federal Reserve the authority to pay interest on balances that depository institutions hold in their accounts at the Federal Reserve Banks. The Federal Reserve announced yesterday that it will pay interest on required reserve balances at 10 basis points below the target federal funds rate, and pay interest on excess reserves, initially at 75 basis points below the target. Paying interest on reserves should allow us to better control the federal funds rate, as banks are unlikely to lend overnight balances at a rate lower than they can receive from the Fed; thus, the payment of interest on reserves should set a floor for the funds rate over the day (my emphasis).

Thus, although the Fed was now chiefly concerned, not with relieving banks of an implicit tax, but with reinforcing its ability to hit its federal funds target, its plan was to do so in a manner that nevertheless complied with the letter, if not the spirit, of the 2006 law, by having IOR serve as a new, non-zero lower bound to the federal funds rate.

Alas, things didn't work out quite as Bernanke and other Fed officials intended. Instead, the "floor" they'd laid out so carefully turned out to be rotten, chiefly because, although they keep balances with the Fed, Fannie and Freddie and other GSEs aren't eligible for IOR. Consequently, their involvement created an arbitrage opportunity that Fed officials hadn't anticipated, with banks borrowing funds from GSEs overnight at rates sufficiently below the IOR rate to turn the banks a tidy (if modest) profit.

The crux of the matter is that the effective federal funds rate — that is, the rate that was actually being paid for overnight funds — quickly ended up falling below the IOR "floor" and, therefore, below the  Fed's target rate. In fact, as the red plot in the figure below shows, since December 2008, when the Fed set the IOR rate for both required and excess reserves at 25 basis points, the rate has always exceeded the effective federal funds rate, besting it on occasion by as much as 19 basis points.


Faced by this reality, the Fed made the best of a bad job by declaring (1) that instead of setting a fed funds rate target it would henceforth set a target "range;" and (2) that the rate of IOR was to define, not the lower bound (or "floor") of the new target range, but the upper bound.

Man, I bet the Board of Governors makes some mean lemonade!

But while the Fed may have succeeded in saving face, it doesn't follow that it managed to do so while still obeying the law. For converting the IOR rate from a floor to a ceiling meant setting it above rather than at or below "the general level of short-term interest rates," taking that "general level" to be appropriately represented by the effective federal funds rate. Nor does letting the three-month T-bill rate proxy the "general level" of (risk-free) short term rates — a reasonable alternative — get the Fed out of hot water, since that rate (the green plot in the figure) has generally been even lower than the effective federal funds rate.

The situation hasn't gone unnoticed by Congress. Bill Huizenga (R-Michigan), Chairman of the Financial Services Committee's Subcommittee on Monetary Policy and Trade, drew attention to the matter following  Janet Yellen's June 22, 2016, Humphrey-Hawkins Testimony:

HUIZENGA: Thank you, Mr. Chairman, and back here, Chair Yellen.

So, in response to the financial crisis, the Emergency Economic Stabilization Act accelerated its authority that had been granted to start paying interest on reserves from 2011 back to October 1 of 2008. And according to the New York District Bank, the Fed expected to set interest on reserves well below the Fed's target policy rate, that is, the federal funds rate. Had the Fed created such a, quote, "rate floor," it would have complied with the letter of the law.

Section 201 of the Financial Services Regulatory Relief Act of 2006 explicitly states that interest on reserves can, quote, "not exceed the general level of short-term interest rates." However, as we learned in last month's Monetary Policy and Trade Subcommittee hearing, interest on reserves is above the Fed funds rate.

This above-market rate not only appears to have gone outside the bounds of the authorizing statute, it may also be discouraging a more free flow of credit in an economy that can and should be flourishing. …

As if taking this as his cue, Jeb Hensarling (R-Texas), Chairman of the House Financial Services Committee, and one those responsible for introducing the 2006 legislation, grilled Yellen remorselessly on the subject:

HENSARLING: And as I think you know, Section 201 of the Financial Services Regulatory Relief Act says that payments on reserves, quote, "cannot exceed the general level of short-term interest rates." Today, you are paying 50 basis points on interest on excess reserves. The fed funds rate yesterday, I believe, is 38 basis points. Is that correct?

YELLEN: Probably correct.

HENSARLING: So, you're paying about — back to the (inaudible) calculation — a 35 percent premium on excess reserves. You're paying a premium to some of the largest banks in America, is that correct?

YELLEN: Well, I consider a 12 basis point difference to be really quite small and in line with the general level of interest rates.

HENSARLING: OK. So, you believe you have the legal authority to do this, otherwise you wouldn't do it, is that correct?

YELLEN: Well, I do believe we have the legal authority to do it…

HENSARLING: Madam Chair, would it be legal…

YELLEN: Our (ph)…

HENSARLING: Would it be legal for you to pay a 50 percent premium? You're paying a 35 percent premium today. Would it be legal to pay 100 percent premium?

YELLEN: I believe it's a small difference. And interest on excess reserves did not succeed as expected in setting a firm floor…

HENSARLING: And would it be legal…

YELLEN: … on the (inaudible) short-term interest rates…

HENSARLING: Would it be legal under the statute — would it be legal under the statute for you to pay twice the Fed's fund rate as a premium on interest on reserves?

YELLEN: Well, I believe that the way we are setting it is legal and consistent with the act.

HENSARLING: No, I know. But that's not my question.

YELLEN: It is — it is…

HENSARLING: What is the legal limit? What is the legal limit on which you can pay? What does the phrase exceed the general level of short-term interest mean? You're saying that 12 basis points does not trigger the statute. At what point is the statute triggered?

YELLEN: It depends on exactly what short-term interest rate you're looking at. There are a whole variety of different rates and…

HENSARLING: OK. Do you have an opinion on whether…

YELLEN: … whatever…

HENSARLING: … or not it would be legal to pay 100 percent premium?

YELLEN: Whatever level we set, the interest on reserves…

HENSARLING: Madam Chair, please, it's a simple question.

YELLEN: … at, it funds (ph) going to trade below that level.

HENSARLING: Madam Chair, please, it's a simple question.

YELLEN: It funds going to — to trade below that level.

HENSARLING: Madam Chair, please. It's a simple question. Would it be legal under the statute to pay a 100 percent premium? If you don't know the answer to the question, you don't know the answer to the question.

YELLEN: Well, my interpretation is that it is legal.

HENSARLING: It would be legal to pay twice the market rate? That would not exceed the general level of short-term interest?

YELLEN: There is likely to be for quite some time a small number of basis points gap…


YELLEN: … between interest on reserves and the Fed funds rate, and that is something that…

HENSARLING: I would simply advise discussing that with the legal counsel, because I think that, frankly, it (inaudible) common sense.

I'm going to go out on a limb and guess that Hensarling's last "inaudible" word was "defies."

Whatever the word was, it sure seems to me that, no matter how one slices it, an IOR rate "a small number of basis points" above the fed funds rate is one that "exceeds" that rate. But I'm not a Federal Reserve lawyer, so what do I know? Still, I wish someone deeply committed to making sure that financial institutions don't get away with any hanky-panky (the CFPB, perhaps?) would go ahead and sue the Fed, so that Representative Hensarling and I can find out once and for all just what "not to exceed" really means.


*That is, it's ability to "sterilize" its emergency loans by disposing of Treasury securities.

  • Short answer is probably yes reading the letter of the law, but real issue is whether Fed Funds is a "free" rate or the result of the monopoly power of the largest money center banks. The rate paid on reserves is effectively an alternative or floor to the rigged market maintained by the top banks, who are generally buyers of funds from the smaller depositories. Now, does any member of Congress understand the above? No.

  • JP Koning

    "Still, I wish someone deeply committed to making sure that financial institutions don't get away with any hanky-panky (the CFPB, perhaps?) would go ahead and sue the Fed, so that Representative Hensarling and I can find out once and for all just what "not to exceed" really means."

    What do you suggest the Fed can do to skate back onside? The Fed could start paying interest to the GSEs, thus fixing the leak, but that would be breaking the law too since GSE's can't legally receive interest on reserves.

    • George Selgin

      Since the Fed can't legally pay "negative" interest on reserves (the various schemes for getting around the statute wording here all being too transparently dishonest to be seriously contemplated), the best thing it can do at the moment is to return to zero IOR, and to also shut down the ON-RRP facility, while preparing to sell securities, loss or no loss, should bank lending show signs of a more complete revival. (Whether it will do so is a matter for debate. No one is quite sure to what extent IOR, rather than other factors, is contributing to the demand for excess reserves.)

      In short, the Fed should make a genuine effort to normalize monetary policy, instead of merely promising to do that at some unspecified date in the future.

      • JP Koning

        "the best thing it can do at the moment is to return to zero IOR, and to also shut down the ON-RRP facility, while preparing to sell securities, loss or no loss, should bank lending show signs of a more complete revival."

        Why not just modify section 19 of the Federal Reserve Act so that GSEs can receive IOR? Problem fixed. Seems way easier to me.

        • George Selgin

          The problem there is that it perpetuates the present dog-and-pony show, in which the Fed pretends to be doing business-as-usual, by "setting" interest rates, when in fact it is presiding over a moribund fed funds market, while and otherwise exercising very little reliable control over money and credit.

          • JP Koning

            Why is it bad to have a moribund fed funds market?

            If section 19 is updated to allow GSE IOR, the fed funds market completely disappears but at least there's no more divergence between the fed funds rate and IOR, and no legal question.

            The Fed would be operating what I believe Steve Williamson calls a floor system:


            You say it would exercise little control over money, but from what I understand a floor system is just as adequate at carrying out monetary policy as the Fed's pre-2008 no IOR system.

          • George Selgin

            The short answer is that closing the ffr merely eliminates one potential proxy of the "general level short-run interest rates." To suggest that by doing this the Fed could interpret "general level of short-term interest rates" however it pleases is (not to put too fine a point on it) sheer casuistry. The law's clear intent is to avoid any implicit subsidy of bank deposits by the Fed. Lack of an ffr to refer to would instead warrant treating some other short-term market rate, such as that on T-bills, as the best available proxy for the "general" level of such rates.

            I'm struck here and in much else I read from monetary economists these days by the cavalier attitude of many concerning the rule of law. It's as if any sort of clever legal legerdemain is justified so long as it might allow the Fed to implement some policy that they consider convenient. (Ken Rogoff's offhand dismissal of the contractual rights of bank depositors, not to mention general privacy rights, is an especially egregious case in point.)

            As for the "floor" system, I am far from convinced that it would work the same was as the pre-2008 arrangement. A set of administered interest rates is, first of all, not the same as a market rate. The pre-2008 fed funds target represented the opportunity cost to banks of retaining reserves; an administered IOR represents the cost to them of parting with reserves. Suppose an increase in the demand for money. In the old system, that leads in the short run to an above-target ffr, and to subsequent reserve injections aimed at restoring the ffr to target. In the present system, the IOR rate, being strictly administered, is identically equal to the target rate, so there is no sense in which movements in it serve as a signal for any monetary policy adjustment.

            This is just one off-hand observation on the matter. I believe that much more could be said regarding the substantial difference between the floor regime (or the actual regime in place now) and the pre-2008 regime. The prevailing tendency of so many authorities, not to mention lay persons, to treat a Fed rate "setting" as having the same significance in the new as in the old arrangement seems to me to be a category mistake of the worst kind.

          • JP Koning

            You speak in favor of the Fed's pre-2008 regime.

            My understanding is that IOR and the intervening floor system is really just a setup for the Fed to eventually set up a third sort of regime, a channel system much like that run by the Bank of Canada of the Reserve Bank of Australia. In a channel system the Fed funds rate would trade a bit above IOR (and a bit below the discount rate), and you'd get signals from it that allow you to adjust monetary policy. Does your preference for the pre-2008 Fed setup extend to a BoC-style channel?

            "…the best thing it can do at the moment is to return to zero IOR, and to also shut down the ON-RRP facility, while preparing to sell securities, loss or no loss, should bank lending show signs of a more complete revival."

            I fear that even your preferred option would have the Fed breaking the law. Sure, the fed funds rate would trade at 0% along with IOR, but the rate on t-bills would probably be around -0.1%. T-bills are highly valued as a means of exchange, or as collateral–so much so that investors will pay a premium over IOR to own them.

          • JP Koning
  • Andrew_FL

    "violates" would also work in that context.

    We really need some kind of Constitutional prohibition on statutory Weasel Words like "general level" or making reference to short term rates without specifying some intended benchmark.

    • George Selgin

      You are quite right–the law is badly written. But bear in mind, it may be so intentionally. It is, sadly, routine for the Fed to "assist" legislators by having its own attorneys go through pending bills, so as to suggest various "improvements." So very generous of them!

      Still, the intent of the law seems clear enough to me. I hope others agree.

  • Benjamin Cole

    Well great post, but "normalize"?

    The combination of fiat-money central banks and inflation targets appears to result in nearly universal asphyxiation of commerce.

    What is "normal" for independent central banks is to suffocate growth through tight money.

    Nearly every part of the globe that has a central bank with an inflation target is well below their inflation target and mired in slow growth, deflation, or recession.

    • George Selgin

      Hi Benjamin. By "normalize" I didn't mean to suggest a return to any particular past policy. I meant only a return to the old operating procedures by which the Fed exercised monetary control by altering the supply of "fed funds." And, FWIW, I've never been a fan of inflation targeting.

      In fact under the present "abnormal" arrangement it isn't clear whether the Fed can "target" anything.

      • Benjamin Cole

        Great post, as I said. But I think I am a fan of helicopter drops and QE…not sure we can go back to old days of tinkering with interest rates only…
        What if actively expansionist central banks are needed for a few decades?

  • Max

    I wish the Congresssman would have replied, "Since you say it's a small amount of money, would you commit to paying it out of the salaries of Federal Reserve economists?" (Of course they couldn't pay it, it's in the billions of dollars since 2008).

    Clearly the Fed has enough smart people working for them to figure out a solution and implement it immediately if they wanted to. They just don't want to.

  • Max

    (Incidentally, I'm aware that the Fed has reported large profits in recent years. But let's face it, that's by luck rather than by design. And it has nothing to do with overpaying IOR. A CEO that steals money from the corporate treasury isn't excused because the company is making money).

  • Ralph Musgrave

    The whole business of minimum reserve requirements being a tax on banks is nonsense. There is no justification for paying any interest on reserves. Reasons are thus.

    Dollars issued by the Fed are the basic currency of the US. In addition of course, private banks issue “promises to pay Fed dollars”. Those promises are themselves a form of money.

    Now if someone chooses to have an stock of Fed dollars worth $X then bully for them, but there is no obligation on taxpayers to pay the holder any interest, any more than there is an obligation on taxpayers to pay interest to people who keep dollar bills in their wallets.

    As it happens, households and non bank firms cannot have accounts at the Fed (though the possibility that they SHOULD do is being seriously considered at the moment). So those households and firms have to use commercial banks as agents when depositing money at the Fed. But the same principle applies: there is no obligation on taxpayers to pay “money holders” or their “agents” any interest.

    Also, one of the purposes of imposing minimum reserve ratios on commercial banks is that it is seen (rightly or wrongly) as a way of improving bank safety. I see no reason for taxpayers rewarding banks for behaving in a safe manner, any more than there is a reason for taxpayers rewarding drivers who keep to speed limits. Punishing miscreants is OK, but there are better things to do with taxpayers’ money than rewarding normal safe behaviour whether it’s drivers or banks.

    • Spencer Hall

      Ralph Musgrave

      You have NO idea what you're talking about.

      Contrary to Nobel Laureate Dr. Milton Friedman, IBDDs are not a tax. They are "manna from Heaven". , CBs [as a system] acquire free legal reserves via open market operations (i.e., manna from Heaven), & on this basis, create a multiple volume of new money & credit ex-nihilo (and acquire a concomitant volume of additional earning assets).

      It is unethical for special interest groups to have preferential, indeed a crony self-serving privilege, i.e., sovereign right, to profit from the creation of the publics’ legal tender.

      As Willie Sutton said: his reason for robbing banks is 'That's where the money is'

      The great German poet and playwright Bertolt Brecht would have agreed and once said it was "easier to rob by setting up a bank than by holding up (one)."

      The axiom is that if private profit institutions are to be allowed the “sovereign right” to create money, they must be severely circumscribed in the management of both their assets & their liabilities – or made quasi-gov't institutions.

      Thomas Jefferson's my favorite: "I sincerely believe the banking institutions having the issuing power of money are more dangerous to liberty than standing armies."

      But remunerating IBDDs was one of the greatest economic blunders in history. It literally destroyed non-bank lending/investing (a monumental theoretical error).

      • Spencer Hall

        All DFI TDs, time/savings deposits are derived from DDs, other bank deposits. There is a one-to-one relationship between TDs and DDs. An increase in TDs depletes DDs by the same amount. Whether the public saves or dis-saves, chooses to hold their savings in a DFI, or to transfer them to a non-bank conduit, will not per se, alter the total assets or liabilities of the DFIs; nor alter the forms of these assets or liabilities (TDs or DDs).

        Non-bank financial intermediaries lend existing money which has been saved, and all of these savings originate outside of these non-bank conduits. The utilization of these loan-funds, or the activation of monetary savings held by these NBs, is captured thru the velocity of their transactions in the commercial banking system (bank debits/withdrawals), and not thru the volume of their bank deposits (the volume of existing money, the residual, is left unchanged).

        From the standpoint of the economy, NB deposits never leave the CB System. And
        the growth of the NBs is prima facie evidence that existing funds/savings have already been invested/spent, i.e., transferred/transmitted by their owners/savers/creditors to borrowers/debtors. Otherwise, this would represents
        a double counting of the money stock.

        I.e., the CBs are credit and money creators, the NBs are credit transmitters.

        • Spencer Hall

          All savings originate within the commercial banking system. And saver-holders never transfer their funds out of the commercial banking system
          (unless they hoard currency). But savings are not synonymous with the omney supply.

          Shifts from savings deposits, TDs, to transaction accounts, TRs, within the CBs & the transfer of the ownership of these deposits to the non-banks,
          involves a shift in the form of bank liabilities (from TD to TR) & a shift in the ownership / title of (existing) TRs (from savers to NBs, et al). The utilization of these TRs by the NBs has no effect on the volume of TRs held by the CBs, or the volume of their earnings assets. I.e., the non-banks are customers of the deposit taking, money creating, CBs. This applies to all investments made directly or indirectly through the non-banks.

          If savings are "lent" to the commercial banks (where banker's pay to attract and hold deposits), there is, from the system's belvedere, no change in
          volume of deposits, no change in the volume of assets, nor any change in the
          volume of excess reserves.

          The source of time (savings) deposits is other bank deposits, e.g., demand

          Never are the commercial banks financial intermediaries (conduits between
          savers and borrowers), in the savings-investment process (as the 300 Ph.Ds. on the Fed's technical staff all surmise). CBs do not perform the same functions as non-banks. All inducements for the public to hold idle deposits in the commercial banking system are deflationary, viz., the remuneration of IBDDs (which exacerbated the downswing in money velocity), flights-to-safe FDIC deposit coverage, etc.

          Unless monetary savings (bank-held savings), are expeditiously activated, and otherwise put back to work (matched with non-inflationary real-investment
          outlets), money velocity shrinks, AD shrinks, and gDp shrinks (i.e., all
          incomes), i.e., ever since 1981 when the rate-of-change in DD turnover climaxed – with the widespread introduction of ATS and NOW accounts.

          From the standpoint of the system, savings is a function of the velocity of deposits (as IBDDs are distributed), not a function of their volume. The lending capacity of the CBs isn't predicated on the level of market clearing
          rates (the redistribution of deposits resulting from the bidding wars that exist between individual commercial bankers).

          Net changes in Reserve Bank Credit since the Treasury-Reserve Accord of March 1951 are determined by the FOMC. The CBs could continue to lend even if the non-bank public ceased to save altogether. The lending capacity of the CB system is dependent upon monetary policy, not the savings practices of the public.

  • Jeremy Stein has an interesting take on this. He said the RRP is 5 basis points. The IOR is 25 basis points, and the Fed funds rate is something in between. The RRP and the IOR then become a way for the Fed to raise the Fed Funds rate and he says raisng the RRP and IOR would automatically raise the Fed funds rate. He looks at the higher IOR as a useful tool. But then he negates himself by saying we are too close to the Zero Lower Bound to implement the raises he talks about: http://www.talkmarkets.com/content/bonds/timid-fed-and-jeremy-stein-and-potholes?post=105246&uid=4798 The problem is that all the money sloshing around in the loose money financial system does not seem to make its way to the tight money real economy.

    • George Selgin

      Stein's "take" was merely the conventional wisdom after the Fed discovered that IOR wouldn't serve as a ffr floor. I assume that his remarks were made prior to December 2015, when the Fed's target range was doubled.

  • Benjamin Cole

    I take a fun potshot at alt-m and pose that fiat-money central banks are deflationist-statist agencies beholden to bondholders over at Historinhas

    • George Selgin

      Well, it would be a more effective potshot is it answered my response to your remark on Larry's Tom Paine post! (It would also help if you pointed out actually examples of the bias you detect here.)

  • Spencer Hall

    The payment of interest on excess reserves is not a tax. Commercial banks always create new money when they lend/invest. Without remuneration, IBDDs are "Manna from Heaven". Remunerating IBDDs induces non-bank dis-intermediation, destroys money velocity, and thus AD. Remunerating IBDDs accelerates secular stag(fl)ation. Alas, remunerating IBDDs separates real economists from Keynesian economists.

  • Spencer Hall

    The idiots that study economics don't know money from mud pie. The Fed has increasingly overstated M1 since the DIDMCA of March 31st 1980 (which caused the July 1990 Mar 1991 recession), and increasingly understates IBDDs. The Fed omits, the credit created by banks, from commercial bank credit, i.e., the CU's, MSB's, and S&L's loans and investments are erroneously omitted. I.e., the Fed never modified its money stock definitions.

    What Bernanke did, and did all by himself, was create the GR. Then he made it much worse by destroying non-bank lending when the economy was already contracting. And you can tell who understands economics. No one. Otherwise, they would be referring to the 1966 S&L credit crunch, or the S&L crisis (where in order to survive the NBs had to act like CBs).

  • Spencer Hall

    CBs do not loan out existing deposits saved or otherwise. In "The General Theory of Employment, Interest and Money", pg. 81: John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution (non-bank), serving to join the saver with the borrower
    when he states that it is an “optical illusion” to assume that “a depositor & his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”

    In almost every instance in which Keynes wrote the term bank in the General Theory, it is necessary to substitute the term financial intermediary (non-bank) in order to make his statement correct. This is the source of the pervasive error that characterizes the Keynesian economics (that there's no difference between money and liquid assets), the Gurley-Shaw thesis, the elimination of Reg. Q ceilings, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, the Financial Services Regulatory Relief Act of 2006, the Emergency Economic Stabilization Act of 2008, sec. 128. “acceleration of the effective date for payment of interest on reserves”, etc.

  • Spencer Hall