https://www.youtube.com/watch?v=vyLnDop6Ux4
Mixing up the primary and secondary bond markets.... the banks are getting an asset in the primary market - an asset that gets NO interest... and so the government offers to trade those "reserves" for a secondary market. The yield on the reserves is less than the yield on bonds. You can't trade reserves.
It's the rate on reserves versus the primary market (not the secondary market) - the government sets the rate on reserves. The government will always buy bonds since they're a better return rate than the reserves.
leading up to the 2008 financial crisis there was no interest rate on reserves....
the fact that the on the primary market the funds that are used to buy the bonds are created by the deficit itself. So the government spends more than it gets back in taxation that creates reserves. Those are the funds that are used to buy initial bonds in an auction.
10% of GDP as reserves were created from QE but only .1% were sold each day in the primary market...
there's
100 times as many reserves outstanding as actually needed to buy the
bonds that are on offer. And because the bonds offer a higher yield than
can be traded, everybody will who who can bid will bid. There'll be overs subscribed bids. This is the standard situation.
Yes, quantitative easing (QE) directly increases the reserve accounts that commercial banks hold at the central bank
That will affect the price of bonds on the secondary market, but that is nothing to do with the primary market.
Effective March 26, 2020, the Board reduced reserve requirement ratios
to zero percent. This action effectively eliminated reserve requirements
for all depository institutions. Consequently, all funds banks hold on deposit are technically excess reserves, currently totaling over $3 trillion
Interest on Reserve Balances (IORB): The Fed pays interest on these excess funds, which serves as a primary tool to establish a floor under the federal funds rate
Yes, during Quantitative Easing (QE), the Federal Reserve effectively provided the banking system with vast amounts of "free reserves." [1]
During QE, the Fed creates digital money to purchase long-term assets (like Treasury bonds and Mortgage-Backed Securities) from financial institutions. When the Fed buys these assets, it credits the seller's commercial bank with an equivalent amount of new, digital central bank reserves. Because these reserves are created out of thin air to pay for the assets, they act as free reserves injected directly into the banking system
For the most part, central banks weren’t actually “printing money”.
Rather they were buying longer-term bonds paying 2% interest with newly
issued interest bearing reserves, which at the time paid almost no
interest at all. Central banks were essentially operating the world’s
largest hedge funds. Borrowing short-term at low rates and lending
long-term at a higher rate.
https://www.econlib.org/time-to-pay-the-piper/
Banks, considered together, have no choice but to hold the reserves
QE has force-fed into the system. Compelling them to do it for nothing
would be a form of financial repression which may impair banks’ ability
to lend. It would “transfer the costs [of rising rates] to the banking
sector,” Sir Paul Tucker, a former deputy governor of the Bank of
England, told parliament in 2021.
The current interest rate banks earn on reserve balances (IORB) parked at the Federal Reserve is 3.65%.
Back in 2007, short-term interest rates in the US were about 5% and thus
banks held only a tiny amount of excess reserves. Today, excess
reserves are now roughly 1000-fold higher than before the Fed began
paying IOR in 2008. ..
Central banks determine the nominal stock of reserves, while the
commercial banking system determines the real stock of reserves.
To be sure, central banks can induce commercial banks to hold a very
large stock of reserves—even in real terms—if they are willing to pay
sufficient IOR. But if you assume that no interest would be paid on
most bank reserves, why would banks choose to hold large a real stock of
excess reserves?
If all banks simultaneously tried to get rid of excess reserves, this
would lead to changes in the prices of goods, services, and assets.
Eventually, the price level would rise high enough so that banks were
holding their desired real stock of reserves. But when you consider
that excess reserves in America are roughly 1000-fold higher than in
2007, the required price level increase would presumably be very large. ...
The commercial banks acquire “free” legal reserves, yet the bankers
protested that they didn’t earn any interest on their balances in the
Federal Reserve Banks.
Given bankable opportunities (and the Federal Government is the largest
creditworthy borrower providing zero risk-weighted assets), on the basis
of these newly acquired free reserves, the commercial banks created a
multiple volume of credit and money. And, through this money, they
acquired a concomitant volume of additional earnings assets.
How much was this multiple expansion of money, credit, and bank earning
assets? Thanks to fractional reserve banking (an essential
characteristic of commercial banking) for every dollar of legal reserves
pumped into the member banks by the Fed, the banking system acquired
about $206:1 (c. 2006), dollars in earning assets through credit
creation.
https://talkmarkets.com/article/bank-reserves-and-loans-the-fed-is-pushing-on-a-string?post=64407
The Fed is anxious to spark more lending/borrowing, and it has lowered
interest rates to near-zero and made it easy for banks to build
reserves--two things that in previous eras would have sparked increased
borrowing.
Commercial banks acquire earning assets through the creation of new
money. When commercial banks make loans to or buy securities from the
nonbank public new money- demand deposits are created in the banking
system.
The aggregate lending capacity of the payment’s System is determined by
the monetary policy of Federal Reserve Authorities. It is in no way
dependent on the savings practices of the public.
https://fred.stlouisfed.org/graph/?g=UheC
The real interest rate is the true cost of borrowing or the actual yield on savings after adjusting for inflation. It represents your true change in purchasing power. If a savings account pays 5% and inflation is 3%, your real interest rate is 2%
FFR (Federal Funds Rate) is the interest rate banks charge each other to borrow or lend reserve balances overnight. The rate banks earn on funds held directly at the Federal Reserve is called
IORB (Interest on Reserve Balances). The Fed uses the IORB to anchor the FFR.
[1, 2, 3] The distinction operates as follows:
- Federal Funds Rate (FFR): The rate commercial banks charge each other in the private market for overnight loans of reserves.
- Interest on Reserve Balances (IORB): The rate the Fed pays banks for keeping their money in reserve at the central bank
ZLB (
Zero Lower Bound) is the macroeconomic concept that short-term nominal interest rates cannot realistically fall below zero. It limits a central bank's ability to stimulate the economy during a recession because people and banks would rather hold cash (which yields 0%) than accept a negative return.
[1, 2] It is closely related to, but distinct from, the Interest on Reserve Balances (IORB) or Interest on Excess Reserves (IOER). While the ZLB refers to the "zero floor" limit for monetary policy, the IORB is the actual positive interest rate central banks (like the Federal Reserve) pay to commercial banks on the reserve funds
The Federal Reserve provided central banks and commercial banks with trillions of dollars in excess reserve deposits, reaching peak excess reserves of roughly $4.2 trillion in late 2021. These massive reserve balances were created as the direct liability counterpart to the Fed's quantitative easing (QE) asset purchases
Great Recession (2008-2014): Initial large-scale asset purchases caused bank reserves at the Fed to surge to around $2.8 trillion, which unexpectedly became trapped as excess reserves rather than immediately entering the broader money supply. [1] COVID-19 Pandemic (2020-2022): The Fed purchased approximately $4.6 trillion in securities, boosting peak reserve balances to an all-time high of roughly $4.2 trillion Since then, the Fed has utilized quantitative tightening (QT) to shrink its balance sheet and reduce these overall reserve deposits to around $3 trillion, which the Fed considers the baseline for an "ample reserves" monetary policy framework
https://www.minneapolisfed.org/article/2015/should-we-worry-about-excess-reserves
the nation’s fractional banking system allows banks to convert excess
reserves held at the Federal Reserve into bank loans at about a 10-to-1
ratio. Banks might engage in such conversion if they believe other banks
are about to do so, in a manner similar to a bank run that generates a
self-fulfilling prophecy.
Policymakers could guard against this inflationary possibility by the
Fed selling financial assets it acquired during quantitative easing or
by Congress significantly raising reserve requirements.
So, 60 percent of the entire monetary base is now in the form of excess reserves compared to roughly 0 percent precrisis.
Since each dollar of bank deposit requires approximately only 10 cents
of required reserves at the Fed, then each dollar of excess reserves
can be converted by banks into 10 dollars of deposits. That is, for
every dollar in excess reserves, a bank can lend 10 dollars to businesses or households and still meet its required reserve ratio.
Thus, if every dollar of excess reserves were converted into new loans
at a ratio of 10 to one, the $2.4 trillion in excess reserves would
become $24 trillion in new loans, and M2 liquidity would rise from $12
trillion to $36 trillion, a tripling of M2.
The U.S. M2 money supply is currently at $23.05 trillion. This metric reflects a 5.58% year-over-year increase.
a central bank that commits to pay a given nominal interest rate on
excess reserves, but where banks are free to convert these excess
reserves to loans at any time.1
Within this setting, we consider two scenarios: In the first,
households, firms and banks all expect inflation to be low. In this
scenario, the interest rate offered by the Fed is sufficiently high
relative to the interest rate banks could get by loaning out their
excess reserves to induce the banks to leave the excess reserves at the
Fed.
In the second scenario, households, firms and banks all expect inflation
to be high. Given this expectation, households and firms will be
willing to pay higher interest rates to banks for loans since they
expect to pay back in cheaper dollars. In this situation, the Fed’s
interest rate on excess reserves is no longer high enough to induce
banks to leave their reserves at the Fed, and when banks convert their
excess reserves to loans, they create extra liquidity that generates
higher inflation. Thus, the expectation of higher inflation induces the
reality of higher inflation.
One possible solution would be for the Fed to severely reduce its
balance sheet by selling to banks the financial assets it acquired
during its quantitative-easing episodes. This would automatically lower
the banks’ excess reserves.
In exchange for the newly created bank reserves injected into the financial system, the Federal Reserve acquired two primary types of financial assets:
[1] - Treasury Securities: The Fed purchased large quantities of U.S. government debt (such as Treasury bonds and notes) to lower long-term interest rates. [1, 2, 3]
- Mortgage-Backed Securities (MBS): The Fed also bought MBSs issued by government-sponsored enterprises and federal agencies
By digitally creating these central bank reserves, the Fed effectively swapped the public's or financial institutions' longer-term, interest-bearing securities for highly liquid, cash-like reserve balances.
Another potential solution is for Congress to make the policy and legal changes necessary to convert excess reserves into required
reserves by dramatically increasing required reserve ratios, perhaps
to 100 percent (and possibly compensating banks by paying adequate
interest on these reserves).2
In a separate paper (Chari and Phelan 2014), V. V. Chari and I
consider the costs and benefits of implementing a 100 percent reserve
requirement and argue that the costs of such a requirement shrink as
communications technologies improve, with the usual and oft-cited
benefit that bank runs are eliminated.
The Federal Reserve sets the required reserve ratio for all depository institutions at
0%. Because there are no required reserves, banks are not legally required to hold a minimum against customer deposits. Any reserves a bank holds at the Fed are considered
excess reserves.
[1, 2, 3]The U.S. central bank dropped reserve requirements to zero percent in March 2020 as part of its pandemic response and continues to operate under an "abundant-reserve" framework. Instead of forcing banks to keep a portion of deposits on hand, the Fed manages the money supply and influences short-term interest rates by paying interest on the reserve balances banks choose to keep with them
https://www.youtube.com/watch?v=HDmXLWH2p9E
https://www.youtube.com/watch?v=MLzncbEc63M
So the discount rate is the ceiling of the primary market difference to the reserve interest rate.
The discount rate (or primary credit rate) acts as the upper bound or ceiling for short-term interbank lending. Because the Federal Reserve lends directly to eligible financial institutions, no bank would logically pay a higher rate to borrow reserves on the primary market than the Fed charges at its discount window
https://fredblog.stlouisfed.org/2024/04/rates-related-to-monetary-policy/
Floor: The Interest on Reserve Balances (IORB) or Overnight Reverse Repurchase (ON RRP) rate
the federal discount rate is a key emergency backstop to prevent bank failures.Secondary credit has an interest rate set above the primary discount rate for troubled banks.The discount rate is set by the Fed's board of governors, unlike the market-set federal funds rate.The Fed prefers banks to monitor each other's credit risk by borrowing at the lower federal funds rate. Essentially 100% of the Treasury securities purchased by the Federal Reserve for Quantitative Easing (QE) are sourced from Primary Dealers
Primary Dealers |
ASL Capital Markets Inc.
Bank of Montreal, Chicago Branch
Bank of Nova Scotia, New York Agency
BNP Paribas Securities Corp.
Barclays Capital Inc.
BofA Securities, Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Daiwa Capital Markets America Inc.
Deutsche Bank Securities Inc.
Goldman Sachs & Co. LLC
HSBC Securities (USA) Inc.
Jefferies LLC
J.P. Morgan Securities LLC
Mizuho Securities USA LLC
Morgan Stanley & Co. LLC
MUFG Securities Americas Inc.
NatWest Markets Securities Inc.
Nomura Securities International, Inc.
RBC Capital Markets, LLC
Santander US Capital Markets LLC
SMBC Nikko Securities America, Inc.
Societe Generale, New York Branch
TD Securities (USA) LLC
UBS Securities LLC.
Wells Fargo Securities, LLC |
https://www.federalreserve.gov/econres/notes/feds-notes/who-buys-treasuries-when-the-fed-reduces-its-holdings-20240614.html
