Interest On Reserves: A Secret Fiscal Weapon We're Better Off Without

inflationary finance, interest on reserves, Quantitative Easing, budget deficits, Donald Trump
Trojan Piggybank," by Andy Dincher CC BY 3.0, https://commons.wikimedia.org/wiki/File:Trojan_Pig.JPG

Whenever a government agency gains a new power, there’s a risk that, whatever the power’s original intent, it will end up being put to other uses, perhaps good, but often bad.

Such is the case for the Fed’s power to pay banks interest on their Federal Reserve deposits. That power was originally awarded to the Fed in 2006 to allow it, starting in October 2011, to reduce banks' cost of meeting statutory reserve requirements. During the financial crisis the implementation date was moved forward to October 2008, the Fed's hope at the time having been that a positive interest rate on excess reserves (IOER) would establish a new, above zero "floor" for the effective federal funds rate. However, as I explained in a recent post, because subsequent Fed reserve creation left the banking system flush with reserves, banks had no need to borrow federal funds unless they could profit from the difference between the borrowing rate and the IOER. Consequently, the interest rate on reserves, instead of serving as an effective funds rate floor,  ended up becoming a ceiling.

Since the economy began recovering from the crisis, the Fed has relied exclusively on IOER to keep the trillions of dollars in fresh reserves it created during and since the crisis from fueling inflation: by raising the IOER enough, it can always encourage banks to continue sitting on those reserves despite improved lending opportunities: the proportion of excess reserves and other bank assets depends, at least in part, on the relative yields of these alternatives.  A higher rate of IOER thus serves as a substitute, when it comes to reining in lending, spending, and inflation, for reducing the total available quantity of bank reserves, as the Fed might do by selling-off some of the assets it acquired in the course of three massive rounds of Quantitative Easing.

So, the good news is that the Fed has gained a new tool for controlling inflation.  The bad news is that, unless Congress does something to stop it, the Fed could well end up abusing this new tool to help a fiscally-challenged Trump administration (or any later administration, for that matter) paper-over its deficits.

For revenue-hungry governments to get central banks to fund their debts is itself nothing new, of course. The first central banks were set up with little else in mind. And if modern central banks are no longer slaves to national treasuries, they’re still under constant pressure to cater to them — pressure to which they often give in.

The Fed is hardly an exception. Although nominally independent, it set aside its mandate to keep prices stable to help finance two world wars. Then, when Fed Chairman Thomas McCabe tried to limit the Fed’s involvement in financing the Korean War, Truman sacked him. Inflation wasn’t a problem during the Eisenhower years; but it might have been had Eisenhower himself not been both a proponent of balanced budgets and an inflation hawk. When Eisenhower's less fiscally conservative successors again pressured the Fed for support, the eventual result was double-digit inflation. And when the Carter and Reagan administrations at last allowed Paul Volcker to reel inflation in, they did so only because it had become such a scourge that no one thought it prudent to stop him.

Fear of inflation has kept a lid on the Fed’s financing of deficits ever since. But thanks to interest on reserves, it may not do so any longer. Now, if the Fed decides to gobble-up still more Treasury or government-agency securities, putting a like sum of fresh reserves at banks’ disposal, it can still keep inflation at bay by hiking the IOER enough to bribe banks to hoard the reserves instead of lending them out.* As I've noted, the Fed has already been using this strategy to keep the banks from shedding the trillions of dollars in excess reserves they accumulated as a result of three massive post-crisis rounds of Quantitative Easing.

For the Fed to monetize deficits during a recession is one thing; in principle, at least, it can hasten recovery by making up for slack private demand for funds. But at other times it’s likely to do harm, whether it leads to inflation or not. By buying government (or agency) debt, and paying banks to hoard the reserves it creates by doing so, the Fed shunts a bigger share of the public’s savings into the Fed’s coffers, and from there to government or its agents. As more savings are sent the government’s way, fewer are left for private investment, including bank loans to small businesses.  The Fed's tendency to favor Treasury and agency securities when conducting monetary policy operations, though innocuous enough when banks hold only minimal excess reserves so that the Fed leaves only a relatively modest "footprint" on overall credit allocation, becomes a serious matter when banks pile-on excess reserves, turning the Fed into the central-bank equivalent of the abominable snowman.

Inflationary finance has similar consequences.  But while inflation makes headlines, reserve hoarding doesn’t. That’s why the Brave New World of interest on reserves  is so dangerous. Faced with the usual pressure to help the government pay its bills, Fed officials, and a pliant or weak Fed Chair especially, might cave-in to the government’s demands while still meeting the Fed’s inflation targets.  In theory they could go on meeting the governments’ demands until every penny in bank deposits is financing some government spending, leaving nothing for private-sector borrowers.

A farfetched possibility? Maybe not. President Trump is likely to appoint a new Fed Chair in 2018, if not before. He’s also likely to fill two vacant slots on the Federal Reserve Board. Will those appointees be willing to tell a deficit-challenged Trump administration to go fly a kite?  They might: but it wouldn’t be wise to count on it.

And if Trump sticks to his campaign promises, his administration may very well end up swimming in red ink: according to reputable estimates, if carried out, Trump’s spending and tax plans, including his plans for infrastructure spending and wall-building, and his promise to retain some of the most expensive parts of Obamacare, will boost government borrowing by roughly a third within a decade, and could double it by 2036.

Congress shouldn’t risk having the Fed once again become a mere pawn to Treasury. Fortunately, the anticipated reform of the Dodd-Frank Act will provide it with a perfect opportunity to take necessary action. The fix is straightforward: amend the law to allow interest payments on banks’ legally required reserves only, but not on their voluntarily-held excess reserves. If the Fed needs to tighten credit to avoid inflation, it can do it the old-fashioned way, by selling-off securities. (The reasons Fed officials have been offering for not selling off at least some of those securities are, by the way, mostly hogwash.) If the Fed is worried about booking losses, Congress should offer to indemnify it. That’s a small price to pay to keep our monetary system from becoming one big government piggy bank.

________________________________

*Kindly spare me the tedious observation that banks don't "lend out" reserves.  As I've explained more than once in this forum, this expression is merely economists' shorthand, serving to describe the process that begins with banks crediting borrowers' accounts with lent sums, is followed by the borrowers' drawing on their borrowed deposit credits by writing checks or otherwise transferring funds to various payees, and finally, other things equal, by a transfer of reserves from the lending bank to the payees' banks, for the sake of settling inter-bank dues. The outcome of it all is, so far as the lending bank is concerned, much the same as it might be were it to simply hand reserves, in shape of so many stacks of fresh Federal Reserve notes, to those who borrow from it.

  • George,

    I think you need to separate the FOMC's use of excess reserves to fund its purchases of securities from the utility gained by offsetting the monopoly power of the large banks in the short-term funds markets. You and I are in agreement as to the error of retaining these vast securities holdings, especially when the Fed could easily allow these assets to go back into private hands. I have suggested to a number of our colleagues at the Fed that the current appetite for duration on the part of large investors makes this a perfect time to end reinvestment of redemption proceeds and even conduct outright sales.

    But you should consider the utility of allowing the Fed to set the FF rate above the rate that would pertain if the market were left to the likes of JPM, WFC, C and BAC. There is both a monetary and competitive issue here. In terms of competition, the large money centers (which were created by the Fed allowing large bank mergers) would naturally like to keep the overnight funds rate artificially low since they tend to be buyers of funds (at least until the post-crisis period). Community banks, on the other hand tend to be sellers of excess funds. Allowing the Fed to pay interest on required and excess reserves helps to provide a counter to the monopoly pricing power of the largest banks.

    This rate setting issue also has monetary implications, however. In the past you have written that the rationale for paying interest on Fed reserves "was resorted to as a contractionary monetary measure, meant to prevent monetary expansion that would otherwise have taken place as a consequence of the Fed’s post-Lehman emergency lending operations."

    In support of that statement, you quoted Bernanke. In fact, however, his Bernanke quote says the exact opposite: "With this step, our lending facilities may be more easily expanded as necessary."

    THE CLEAR PURPOSE OF GRANTING AUTHORITY TO PAY INTEREST ON EXCESS RESERVES WAS TO LET THE FED "DO ITS JOB" AND LIQUEFY THE SYSTEM WHEN NEEDED. It let the Fed draw funds from banks around the country that had previously (since 1913) flowed (at lower rates) to a few large banks. The large bank monopoly as a "safe" haven is the issue here.

    After Lehman failed, the same thing that happened in the Great Depression happened again. All private sector funds flooded into Treasurys and deposits a a few VERY large banks (primarily JPM). As a result, the Fed was "strangled" with the inability to fund expansionary policies to the extent necessary to rebalance bond markets. In short, therefore, the power to pay interest on reserves was essential to providing the Fed a funding source for expansionary liquidity, NOT a "contractionary" move (though it could later be used to do that as well if and when we ever face inflationary trends).

    The proof if its effectiveness is in the statistics surrounding the implementation of that power. Movements in Fed Funds rates at the time the provision became effective is complete proof that its expansionary impact was necessary and correct. Near the end of the very first day the Fed accepted reserves that bore interest, the Fed Funds rate went absolutely bonkers. It skyrocketed right before the window closed much to the chagrin of the largest banks. The big banks finally had competition in the market for short-term funds.

    In closing, let me say to my colleague that you need to avoid the error of many economists to think that the Fed's monetary operations occur in isolation. In fact, banks set interest rates. Generally the Fed only sets benchmarks and thus impacts expectations (as in the post-election period). The use of interest on reserves is an exception to this rule, but one that is not without some considerable utility in terms of monetary policy if used correctly. We both agree that excess reserves ought to be falling much faster if the Fed did the right thing, ended reinvestment of redemptions and started to reduce its portfolio via outright sales. That is the real error, not the Fed's power to pay interest on excess reserves.

    • It's comments like this one, and the one from Ray above, that highlight a point I have raised in the past; that trying to parse and influence Gosbank monetary policy, and educate fools and paid government economists, is futile, never-ending and ultimately not effective in moving toward free market money and banking. Though maybe that is no longer the goal. It's kind of like flat tax or graduated rates? while the government continues to collect over $4 trillion annually. Rules, discretion, IOER/IOR, my cats chasing their tails, blah blah blah who cares when you are part of the politically connected elite that are bleeding the country dry and guaranteeing Goldman Sachs' profits. George, Larry and Kevin, I have read a lot of your work on free banking and money. Would love to see more of it addressed on this site. IMHO it can be no less futile than suffering these fools.

      • M. Camp

        Could you refute the argument of Ray Lopez?

        If I understand his argument is:

        Implicit assumptions:
        1. Large amounts of govt borrowing didn't crowd out private borrowing during the Reagan admin.
        2. Dr. S is correct that there is now an unprecedented tool for permitting massive govt borrowing without causing inflation

        Implicit logic
        1. (2) is not relevant because (1) is now promoted to an economic law that is valid independently of this change in monetary policy regime (his logic was not presented for this, rather it was stated as a fact)
        2. Therefore there will be no crowding out this time either

        • The Ants work all year gathering sticks, 1,000 of them (their savings), to build new housing for themselves. The Grasshoppers fly in and take every last one to build a palace for El Presidente Grasshopper. El Presidente has a palace, the Ants have no new houses. That's called crowding out and it doesn't matter, btw, if the sticks are stolen, "taxed" or borrowed. As folks like to say, "the debt doesn't have to be repaid". Even if the sticks will be repaid, good luck, at a minimum the Ants will not have their houses for a while.

          During the Reagan years, spending human and natural resources on building missile systems, etc., instead of housing, crowded out private investment and decreased the amount of housing and other consumer goods available for the citizens to enjoy. How about a current example? I actually drove probably 300 miles today. The infrastructure was fantastic. President Numbnuts, though, would like to blow $1 trillion on "better", whatever that means, infrastructure and a gigantic wall on the US Mexico border to prevent inexpensive high quality products from reaching non-union-member consumers. There is already a shortage of housing and prices are through the roof, but he wants to pull construction workers from building houses and have them build "better" infrastructure and a moronic wall. The labor market is already tight and will lead to higher prices for homes and ultimately, less homes. That is the government crowding out the private sector.

          Dr. S is correct the Fed has a tool to prevent CONSUMER PRICE inflation as MEASURED BY THE GOVERNMENT. There has been, however, massive inflation in bonds, stocks, all types of real estate, higher education, medical services, collector cars and paintings, etc. Cantillon wrote about this in the early 1700's, the impact of additional money supply, and the transmission of that new money in to the economy. The first recipients of the new money benefit the most, and where they spend it will determine where price inflation appears. Also, just because consumer prices, as measured by the government, are not going up, does not mean there is not inflation in consumer prices. Read Selgin Less than Zero.

          I, btw, support a certain level of military spending. If there is to be a government at all it should be there to ensure a peaceful and tranquil environment in which producers can pursue life, liberty and happiness. Even a minimal amount of resources, however, spent on military endeavors, necessarily crowds out the building of private wealth. The only question is, what is reasonable and what sacrifices are worthwhile to balance wealth and security?

          • M. Camp

            Thanks very much, MC. It's clear now. Basically, it is a dispute about historical facts (Assumption 1., specifically).

            I would like to learn more about this history, esp. from the Alt-M perspective. If you or anyone can point me to a good paper or two on it, I'd be grateful.

            It doesn't seem likely that the good prof would throw out the statement that crowding could happen under the new circumstances if he had not already proved it in some depth, based on factual research (apologies to Ray if I'm wrong on this, and he has some evidence for his facts.)

          • It really comes down to scarcity and whether it is government or not, where there are limited resources, the consumption of one will necessarily crowd out the consumption of another.

            I have expanded my comments in this post:

            https://miltonchurchill.com/2017/01/26/crowding-out/

          • M. Camp

            Thanks, Mr. Churchill. I think you answered my question, by implication if not directly.

            You point out that Government consumption can crowd out private *use of resources* (as opposed to credit, which was the subject of my question). I certainly understand that. And since the feds spent essentially all of the money concurrently with borrowing, the answer to my question is irrelevant.

        • George Selgin

          The conventional "crowding out" argument rests on various assumptions about elasticities, etc., that may not hold in practice. But the crowding out I'm concerned about, connected to increases in the IOER that raise banks' excess reserve holdings, doesn't depend on those assumptions. Whatever raises banks' reserve holdings relative to their deposits serves, ipso facto, to increase the share of bank-intermediated savings that goes to finance the Fed's asset holdings, rather than the non-reserve asset holdings of commercial banks.

          So even if Ray were entirely correct in asserting that there's no merit in the conventional worries about government borrowing crowding out private sector borrowing (and, by the way, he isn't), his claim wouldn't bear on my own concerns about the potential consequences of the Fed's abuse of IOER.

          • Spencer Hall

            "bank-intermediated savings"
            ————

            No, you didn't say that.

    • George Selgin

      Sorry, Chris, but I continue to disagree with you on several of your points. IOR was in fact used as a contractionary measure both when originally employed in 2008, and since; and statements by Bernanke and other Fed officials bear it out, as does the actual economics concerning its effects on the money stock. You can selectively quote all you like, it won't prove me wrong. IOR doesn't help to "liquify" the banking system; when set above market rates, it merely serves to discourage the efficient employment of liquid funds that are already out there.

      As for the Fed's being a safe haven, the correspondent balances of the big New York banks actually expanded after the Fed's establishment, as I document i my Cato PA "New York's Bank." Finally, I don't deny that IOR could be used responsibly. Only it hasn't been used so, and we'd be better off denying the Fed one more tool it can abuse (though, as I have indicated, I would only deny it the power to pay interest on excess reserves.)

  • Ray Lopez

    Selgin: "In theory they could go on meeting the governments’ demands until every penny in bank deposits is financing some government spending, leaving nothing for private-sector borrowers." – weak 'crowding out' argument; the 1980s and Reagan's deficits showed that this is not a concern. The rest of the article was pedestrian. Next!

  • Thank you George!

  • Spencer Hall

    Given:

    All savings (funds held beyond the income period in which received) originate within the payment’s system.

    Savers never transfer their savings out of the payment’s system (unless currency is hoarded or national currencies are converted).

    Savings are never activated (invested) until their owners (saver-holders) contractually, either directly or indirectly (singularly or pooled) via outside (non-bank) conduits, hypothecate their claims.

    All maturity and risk transformation (the distribution and match making of savings with investment outlets) occurs outside the payment’s system (through a non-bank outlet).

    Prima facie evidence of the savings-investment process occurs inside the payments’ system (with savings deposits actually exchanging counter-parties (money velocity or non-bank deposit turnover).

    Thus, according to the macro-economic savings-investment rules of the game, we are currently headed for a protracted economic depression as all bank-held savings are lost to both investment and consumption.

    • Spencer Hall

      The process of monetizing time (savings) deposits began in the early 1960’s. The sharp increase in CB DD velocity since 1964 was the consequence of a variety of factors which include:

      1) the daily compounding of interest on savings accounts in commercial banks and “thrift” institutions (S&Ls, CUs, and MSBs),

      2) the increasing use of electronics to transfer funds (ETF accounts)

      3) the introduction of “negotiable” commercial bank certificates of deposits, and

      4) the rapid growth of ATS (automatic transfers of savings to DDs) and NOW (negotiable
      orders of withdrawal) accounts, and MMDA (money market deposit accounts)

      …all which enabled people to economize on demand deposits (exploit opportunity costs), and resulted in the sharp increase in DD Vt.

      But the most important single factor contributing to the increased rate of money turnover probably were those structural (liquidity) changes which made virtually all time (savings) deposits the equivalent of low velocity demand deposits (viz., the elimination of gate-keeping restrictions, viz., the “monetization” of TDs).

      Auxiliary money, assets diverted that could and were, converted into demand drafts, immensely accelerated DD Vt. Bank customers were induced to shift out of non-interest bearing DDs into TDs by the intro of new demand draft accounts. These developments enabled small savers to large corporations to minimize cash assets thereby accelerating Vt.

      TDs standing alone aren’t inflationary. They are equivalent of DDs with a zero Vt. But they became inflationary when in effect they became interest-bearing demand drafts, and were transformed into a net addition to the money stock thru liquidity enhancements, unrestricted by reserve requirements, and bankers freed to pay whatever the market dictated. There was thus an increased incentive to hold TDs and no restrictions on their growth (leading to the unrecognized increase in AD up until 1980).

      Structural changes in the management and acquisition of time deposits included the virtual elimination of Regulation Q ceilings (caps on rates paid to savers) and the introduction of interest bearing checking accounts. These institutional innovations allow all of us, from the treasurers of the largest corporations, to the smallest savers, to hold any temporary surplus cash in an interest-bearing account which can be shifted at little or no cost, without notice, and no loss of accumulated income (no decrease in asset liquidity synonymous with money velocity), into demand deposits or currency.

      It is quite obvious, that it is monetary flow (volume times velocity) that measures money’s impact on production, prices and the economy.

      See; “Money and Velocity During Financial Crisis: From the Great Depression to the Great Recession: Richard G. Anderson, Michael Bordo, and John V. Duca

      “This study models the velocity (V2) of broad money (M2) since 1929, covering swings in money [liquidity] demand from changes in uncertainty and risk premia spanning the two major financial crises of the last century: the Great Depression and Great Recession. V2 is notably affected by risk premia, financial innovation, and major banking regulations. Findings suggest that M2 provides guidance during crises and their unwinding, and that the Fed faces the challenge of not only preventing excess reserves from fueling a surge in M2, but also countering a fall in the demand for money as risk premia return to normal amid velocity shifts stemming from financial reform.”

      We can, if we want, minimize money velocity, and go back to the days when a savings account was just that – and not an adjunct to our checking accounts.

      • Spencer Hall

        The peak in the "monetization" of commercial bank time deposits (in deposit financial innovation) occurred in the 1st qtr. of 1981. This coincided with the peak in DD Vt. It is a brick wall. Vt cannot be introduced twice. And the current turnover rate of DD Vt is required just to maintain prices, production, and employment at current levels (unless money is expanded as a monetary offset).

        It is significant in that there is a one-to-one relationship between time and demand
        deposits. An increase in TDs depletes DDs by an equivalent amount. If DD Vt cannot increase (because of Alfred Marshall's "money paradox", or its "elastic segment"), then secular strangulation is here to stay.

        • Spencer Hall

          It is not the math, it is the accounting. The deceleration in N-gDp and R-gDp, and corresponding bull market in bonds, is the direct result of the plateau in
          commercial bank deposit turnover in 1981 (MZM velocity parallels this move).
          Prior to this date there was an offsetting increase in money velocity whenever more savings were held / idled (Reg. Q ceilings were raised), in the commercial banking system.

          As savings have become increasingly ensconced and impounded (idled) within the confines of the payment's system (viz., the complete deregulation of the DFI’s interest rate ceilings), money velocity falls, M*Vt falls, AD falls, and incomes fall (the ingredient from which debt is paid). The fall in money
          velocity is directly associated with the decline in non-bank lending/investing
          (i.e., failure to put savings back to work is an inverse velocity relationship).

          The drop in AD (secular stagnation), started when DD velocity climaxed in 1981. Prior to that inflection juncture, DD velocity offset the dampening effect of bank-held savings (as Professor Lester Chandler theorized in 1961, viz., that a shift from DDs to TDs involves a decrease in the demand for money balances and that this shift will be reflected in an offsetting increase in money velocity). Chandler's explanation ran into trouble after the complete monetization of TDs, i.e., as money velocity fell.

          Chandler's model ceased to work. The growth of commercial bank-held savings shrinks aggregate demand and therefore produces an adverse impact on gDp. N-gDp has thus decelerated since 1981 and bond prices have risen commensurately (hence, the 35 year bull market in bonds).

          It was hypothesized in the late 1950’s: “the stoppage in the flow of monetary savings, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods”.

          This is the source of the pervasive error that characterizes the Keynesian
          economics, that there is no difference between money and liquid assets. Never are the DFIs intermediaries (conduits between savers and borrowers) in the savings-investment process.

          All that needs to be done is to get the DFIs out of the savings business, then
          money velocity will accelerate (and the DFIs and NBs will both be more profitable, the CBs smaller, but size isn’t synonymous with profitability). This will also produce higher and firmer real-rates of interest for saver-holders. The 1966 S&L credit crunch is the economic paradigm.

      • Edward C D Ingram

        If you are serious about explaining what you are saying it is best to greatly restrict the use of shorthands and say what you are saying.

        • Spencer Hall

          It's the difference between this country surviving and revolution. But these conventions are well known. Now, I am going to change this world. And it
          will be easy. What I discovered sells itself. First things first.

          Selgin is quite coy. There is no free lunch. MMT temporarily kicks the can down an illusionary path, just like the hedge fund LTCM was guilty of.

          MMT is promulgated by those who literally don’t understand the savings-investment process (i.e., literally don’t understand macro). Figure out how to
          manage your income and investments under totalitarian control and a “command” economy.

          The propagandists can’t think:

          Paying Interest on Reserve Balances: It's More Significant than You Think. Scott T. Fullwiler.

          http://www.modernmoneynetwork.org/sites/default/files/biblio/Setting%20Interest%20Rates%20in%20the%20Modern%20Era.pdf

          https://www.stlouisfed.org/publications/regional-economist/april-2016/interest-rate-control-is-more-complicated-than-you-thought

          Remunerating IBDDs, induces non-bank dis-intermediation. It destroys money or transactions velocity (where savings are matched with non-inflationary real-investment outlets, that process which produced the Golden Era in U.S. economics). The FSLIC used to provide a safety net for the non-banks’ saver-holders. Things have been re-arranged. And this is perverse as the non-banks are the CB’s customers.

          Money flowing through the NBs never leaves the CB system. The CBs simply pay for something that they collectively, already own. They unnecessarily increase their expenses with no concomitant increase in their income. By buying their liquidity instead of following the old fashioned banking practice of storing their liquidity, they (the ABA, the most dominant economic predator), …inadvertently redistribute income to the upper quintiles.

          Unless voluntary savings are expeditiously activated and put back to work, a deceleration in economic activity progressively metastasizes. In macro-economics, unless the upper income quintiles’ savings (which are also proportionately greater), are invested or otherwise put back into circulation thru spending, then a contractionary economic spiral is established and indeed perpetuated. This phenomenon has been artificially diagnosed as secular stagnation (structurally deficient aggregate demand). It first shows up as a decline in durable consumer goods, and then businesses’ capital goods (delimiting long-run productivity and of course, eventually incomes).

          It is not as Alan Greenspan claims, entirely due to increased entitlement spending (dis-savings). It’s due to the ensconced and impounding of
          monetary savings (beginning in the same time frame). The 1966 S&L credit crunch was the economic paradigm.

          The resultant concentration of wealth ownership among the few is inimical both to the capitalistic system and to democratic forms of government. A financial oligarch and a government of, by, and for the people, simply cannot exist side by side. And the exacted toll cannot be measured on the lives of people in terms of the average per capita income, or any other statistic.

          The evidence of inflation, contrary to the conventional wisdom, cannot be conclusively deduced from the monthly changes in the price indices. The price indices are passive indicators of the average change of a group of prices.

    • M. Camp

      Re:
      "All savings (funds held beyond the income period in which received) originate within the payment’s system."

      I trust you, but how can I verify this?

      • Spencer Hall

        It's not a conventional idea. But it is a fact. And you can arrive at the concept and empirical evidence in several ways. And you can verify this up to a certain point in time (as today, ever since the DIDMCA, the Keynesian economists on the Fed's research staff have confused money with liquid assets). I.e., commercial bank credit should also include the S&L's, and CU's credit (like the money stock is combined), etc…i.e., the Fed should definitely be audited.

        The first point is that CBs always, simultaneously, create new money, demand deposits, when they lend/invest (as anyone who has applied double-entry bookkeeping on a national scale should already know). From the standpoint of the economy, they do not loan out existing deposits, saved or otherwise. And bank credit is reflected by both time and savings deposits. Or loans and investments equal deposits. I.e., the growth of money can can be largely accounted for by the expansion of bank credit.

        Savings deposits, rather than being a source of loan funds for the CBs, are the indirect consequence of prior bank credit creation. The source of TDs is almost exclusively DDs, directly or indirectly via the currency route (never more than a short run situation), or thru the CB's undivided profits accounts. Yes, an increase in bank capital destroys the money stock (another one, + $1t, of Bankrupt u Bernanke's many counter-cyclical GR errors). So an increase in TDs depletes DDs by an equivalent amount as there is a one for one relationship between TDs and DDs.

        Increases in currency are always at the expense of DDs, either directly, or indirectly thru the liquidation of TDs, however it cannot be said, as of TDs, that increases in the public's holdings of currency reflect prior commercial bank credit creation. It is more appropriate to say that expansions of currency are accompanied by concurrent expansions of Reserve bank credit.

        Savers, contrary to Congress and the ABA, never transfer their savings out of the CB system, unless currency is hoarded, or national currencies are converted. I.e., the non-banks are the CB's customers. All payments clear thru the CBs.

        To a macro-extent, the non-banks are not in competition with the commercial banks. Savings flowing through the NBs never leaves the CB system. So while the CBs, via
        outbidding the NBs for loan-funds (e.g., remunerating IBDDs), can induce NB dis-intermediation, the opposite, CB disintermediation, cannot exist.

        A shift from time to demand deposits and the transfer of the ownership of these demand deposits to the non-banks does not force a reduction in the size of the
        banking system. These transactions simply involve a shift in the form of bank liabilities (from time to demand deposits) and a shift in the ownership of demand deposits (from savers to the non-banks, et al). Go figure.

        • M. Camp

          My question was badly worded. I meant to ask you for a definition of "savings originating within the payment’s system." I don't understand this term.

          • Spencer Hall

            Funds held beyond the income period in which received. Keynesian economists don't understand the savings-investment process. Funds
            flowing through the non-banks increases the supply of loan-funds, but not the supply of money. Thus, savings flowing thru the NBs lowers long-term interest rates.

            The Golden Era in U.S. economics was where savings were expeditiously activated and matched with real-investment outlets (principally long-term mortgages). And we had FSLIC safety nets for non-bank conduits. Now we only have safety nets for the commercial bank's customers. That's a perverse (even more so in other countries as Sheila Bair pointed out in her book: "Bull by the Horns"), socio-political incentive to hoard savings (decelerate money velocity, the cessation of the circuit income and transactions Vt of funds, funds which constitute a prior cost of production).

            Remunerating IBDDs destroys the savings-investment process. It destroys NB lending/investing. I.e., Bankrupt u Bernanke literally destroyed the
            non-banks.causing the NBs to shrink by 6.2T and the DFIs to be expanded by 3.6T (preventing both the commercial paper market, and the repurchase agreements from recovering). The 1966 S&L credit crunch is the economic paradigm.

            Here is a celebrated intellectual spouting disinformation to cover his butt,
            just like Obama’s “legacy”. Just like in his book, pg. # 56: “The Courage to
            Act” (which should have printed just the opposite); he opined:

            “Unfortunately, beyond a quarter or two the course of the economy is extremely hard to forecast”.

            But he had 2 quarters from the peak in July to the 4th qtr. implosion (which
            had nothing to do whatsoever with housing per his friend and colleague, Alan
            Blinder, as discussed in his book, pg. 18: "After the Music Stopped").

            You see FOMC schizophrenia (like the FOMC's deliberations between the Hawks and the Doves before the economy collapsed in the 4th qtr. of 2008), is where during an economic expansion, interest rates rise, and the proportion of bank-held savings rises as a consequence, creating higher rates of inflation relative to corresponding roc's in R-gDp, i.e., it is a policy where savings are increasingly impounded and ensconced within the confines of the payment's system, slowing real output and producing ever higher levels of stagflation, and depressing AD, which gives the FOMC false signals.

            Bernanke stole everyone’s Treasuries, vitiating Carmen Reinhart and Kenneth Rogoff's rebalancing thesis (by remunerating IBDDs, which inverts the entire Treasury Bill market). Then he established the SFP to cover his butt.

            By stealing everyone's T-Bills, BuB contracted the international, unregulated
            E-$ market. I.e., BuB created the world-wide GR solely by his own incompetence.

        • Spencer Hall

          This is incomplete, but an example:

          The expansion of bank credit & new money-TRs (transaction deposits) by the CBs can be demonstrated by examining the differences in the consolidated condition statements for the banks & the monetary system at
          two points in time.

          Increases in CB loans & investments/earning assets/bank credit, are approximately the same as increases in transaction accounts (TRs) & time
          deposits/savings deposits (TDs)/bank liabilities/bank credit proxy (excluding
          IBDDs).

          That the net absolute increase in these two figures is so nearly identical is
          no happenstance, for TRs largely come into being through the credit creating process, & TDs owe their origin almost exclusively to TRs – either directly through transfer from TRs or indirectly via the currency route.

          There are many factors, which can, & do, alter the volume of bank deposits,
          including: (1) changes in currency held by the non-bank public, (2) in bank
          capital accounts, (3) in reverse repurchase agreements, (4) in the volume of
          Treasury currency issued & outstanding, & (5) in Reserve Bank credit. Although these principle items are largest in aggregate, they nevertheless have been peripheral in altering the aggregate total of bank deposits.

          For the Monetary System:

          Thus the vast expansion of deposits occurred despite:

          (1) an increase in the non-bank public’s holdings of currency $801.2b

          (2) an increase in other liabilities & bank capital $39b

          (3) an increase in matched-sale purchase agreements $32.2b

          (4) an increase in required-clearing balances $6.7b

          (5) the diminution of our monetary gold & silver stocks; etc.(-)$6.6

          (6) an increase in the Treasury’s general fund account $4.9b

          Factors offset by:

          (1) the expansion of Reserve Bank credit $847.5b

          (2) the issuance of Treasury currency; $35.9b

          These “outside” factors made a negligible contribution in bank deposit growth the last 67 years of $4.4b (deposits declined by $877.4b & were offset by the expansion of $883.4b).

          For the incredulous reader I make this assignment: Please explain how the
          volume of TRs & TDs could grow since 1939 from $48 billion, to $ 8,490
          (NSA) billion, even while the banks were paying out to the non-bank public a
          net amount of (-)$801.2 billion (NSA) in currency.

          Federal Reserve Bank credit since 1939 (2.6b), has expanded by $ 847.5 billion (NSA), (-$801.2 of which was required to offset the currency drain from the commercial banks. The difference in the above figures outlined above was sufficient to supply the member banks with $46b of legal reserves.

          & it is on the basis of these legal reserves that the banking system has been able to expand its outstanding credit (loans & investments) by over (+) $8,462 trillion (SA) since 1939. (40.7)

        • M. Camp

          'CBs create new money when they lend'

          This is understood.

          'An increase in TDs depletes DDs by an equivalent amount as there is a one for one relationship between TDs and DDs'

          If I understand the banking system, this is partly correct. The source of an increase in aggregate TD balance includes transfers of DD balances, yes. But also

          — new bank money
          — transfers of base money
          oo — customer currency
          oo — bank reserves (in the case of drafts on accounts at another bank)

    • M. Camp

      It's still not clear, the statement "All savings (funds held beyond the income period in which received) originate within the payment’s system."

      The payment system (I think "payment's") was a typo?) you are referring to checking is accounts, correct?

      If so, since the origin of savings is obviously income, and a checking account can't produce savings, you must mean something else.

      I am also pretty sure that you are not saying that we can tell how much of person's savings is located in any particular balance (checking account, savings account, cash, etc.) since that would be implying that money is non-fungible.

      Could you write (still in simple layman's terms, as you have been using) exactly what you meant to say? I am not an economist nor banking expert. I just know the basics: at a basic level how private banking, the Fed, the Treasury, monetary policy, and so on work; and how the various money supply figures, GDP, and balance of payments are calculated, and so on.

      • Spencer Hall

        Savers never transfer their savings out of the payment's system (the commercial banking system, the DFIs), unless they are hoarding currency or convert their balances to other national currencies. This applies to all investments made directly or indirectly through NBs. Shifts from TDs to DDs within the CBs and the transfer of the ownership of these DDs to the NBs, involves a shift in the form of bank liabilities (from TD to DD) and a shift in the ownership of DDs (from savers to NBs, et. al.). The utilization of these DDs by the NBs has no effect on the volume of
        DDs held by the CBs or the volume of the CB's earnings assets.

        The non-banks are the CB's customers and keep large, and once very profitable, balances in the CB system. I.e., all payments not only clear thru the CB system, but are also warehoused within the CB system. For example to count, say MMMFs, as money, is to double count the money stock. MMMFs represent savings that have already been spent/invested. MMMFs represent a velocity relationship (how savings are expeditiously activated and "put back to work").

        Monetary savings, bank-entrusted savings, all originate from prior bank credit creation. Bank-held savings represent transfers / shifts from prior demand deposits (funds created by the commercial banks when CB's lend/invest).

        Monetary savings are never transferred to the NBs; rather monetary savings are always transferred through the intermediaries. Indeed, as evidenced by the existence of “float”, reserve credits tend, on the average, to precede reserve debits. Therefore, it is a delusion to assume that savings can be “attracted” from
        non-bank conduits; for the funds never leave the commercial banking System.

        • M. Camp

          Thanks for clarifying it, Spencer.

  • Benjamin Cole

    Nice post. I wonder about the interest on reserves program and also the mysterious reverse repos.

    That said, I think the right approach today is helicopter drops. Clean, above board and on a leash.

    With independence, central banks are able to tell a national government to back out—and can also suffocate an economy.