Comment on “Cold Turkey and Moral Hazard”

Thomas Gordon : Writing in Wall Street Journal: December 14, 2017

@Max Gillman Good comments and informatory about why banks are now paid interest  on reserves.   As it concerns the article, I don’t think they were paying a huge interest rate (I thought it was less than 1%, but probably more than most banks were paying depositors ).   Not enough in my mind to get banks to hold excess reserves, but I suppose it is risk free.   The other unspoken thing is that back when Wachovia and WaMu were going broke maybe Fed/Treasury type people were looking for ways to strengthen the banks.  Pay them directly and you get a riot about subsidizing hated banks.   Do it this way and you’re “paying interest on reserves”, a topic that puts most people to sleep.

Avatar for Max Gillman

Max Gillman

@Thomas Gordon @Max Gillman

Thomas, Thank you. The reason why the interest is still “high” is that every time the Fed “raises interest rates”, it is actually raising the Interest rate on excess reserves; the Federal Funds rate remains (since 2008) below the interest rate on excess reserves. This way the Fed induces these 10 systematically important banks to keep holding the (now) $2.1 Trillion in excess reserves. If lent out, and so there were zero excess reserves,  a normal “money multiplier” would cause the money supply to jump by 10 times $2.1 Trillion, or by $21 Trillion dollars. GDP is about that now, so it would be an amount of new money equal to GDP. Inflation would rise significantly, but capital markets would “normalize”. Real interest rates on short term debt would no longer be negative. So I believe the jump in inflation would be best overall, and the elimination of interest on excess reserves the route to such normality in Capital markets.


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