In comments on mine of 16 November I wrote:
Using credit boosts the economy, but it also creates debt, and debt tends to undermine the boost.
Using credit to counteract the drag from debt can work, but it means an ever-bigger new use of credit is required to obtain a boost.
For the past five years the central objective of the Federal Reserve has been to get people borrowing again, because using credit boosts the economy.
They seem not to realize that the longer they postpone the payback, the bigger the payback must be...
Jim responded:
What the Fed has done is maintain the growth of bank deposits in spite of the fact that there has been no growth in bank loans. Apparently bank loans are not the only way to create deposits.
It also appears to me that the Fed's influence on interest is not the only influence it has on bank lending. The Fed has considerable regulatory powers to ensure banks make safe and sound loans. I'm not seeing any evidence of loose policy in this area.
All that makes me wonder how you came up with the notion that the Fed's entire focus has been "to get people borrowing again"?
Well, the above comes to mind because I'm reading Ellen Brown's Amend the Fed: We Need a Central Bank that Serves Main Street. Brown writes:
At an IMF conference on November 8, 2013, former Treasury Secretary Larry Summers suggested that since near-zero interest rates were not adequately promoting people to borrow and spend, it might now be necessary to set interest at below zero. This idea was lauded and expanded upon by other ivory-tower inside-the-box thinkers, including Paul Krugman.
I don't care about negative interest rates and ivory towers. I don't care about Paul Krugman and Larry Summers and Ellen Brown. I just want to answer the question How did you come up with the notion that the Fed's entire focus has been "to get people borrowing again"?
My answer is that people, important people, say things like near-zero interest rates are not adequately promoting people to borrow and spend.
See?
5 comments:
If it is your policy to use private-sector borrowing and spending as a device to get economic growth, then you are likely to end up with an unnaturally high level of debt that creates problems for the economy, and you are responsible for those problems.
In the years since World War Two, Congress promoted and the Federal Reserve allowed a rate of credit growth that far exceeded the rate of money growth. Indeed, money growth was held back to fight inflation while the expansion of credit was used as a way to get growth.
Those policies worked, at the start. They worked until credit use became excessive and the quantity of money insufficient. The policies should have been reversed at that point. But the policies were never reversed, and we suffer for it now.
Hi Art,
I agree with you that Larry Summers thinks the Fed should be doing more to get people to borrow, but that just shows that the Fed's thinking is different than Summers (and Krugman).
As Summers points out the Fed could be doing a lot more to get people borrowing again, if the Fed wanted to. The Fed is paying banks $6 billion a year in interest on excess reserves. Not paying that interest would make banks want to loan more and charging the banks a fee to hold excess reserves as Summers proposes would create an even greater incentive for the banks to lend.
By the way I agree with Ellen Brown that it is good policy to treat federally insured banks as public utilities. There is already a law on the books that does that to a small extent. It's Sen Bill Proxmire's Community Reinvestment Act. There is right now a huge propaganda campaign coming from the corrupt segments of the banking industry to get rid of the CRA because it is so effective at creating the incentives for the banking industry (including the Fed) to behave as a public purpose utility.
"... that just shows that the Fed's thinking is different than Summers (and Krugman)."
:)
You're good.
" Not paying that interest would make banks want to loan more and charging the banks a fee to hold excess reserves as Summers proposes would create an even greater incentive for the banks to lend."
IOR is one of my hobby horses because it's so widely misunderstood. Banks always want to lend. It's how they make profit and banks love... love, love, love profit. Turning away interest income at 3 or 4 or 5 or 10% to wallow in the comfort of %0.25 interest on reserves isn't going to generate bonuses or really even keep the lights on for that matter.
It's also worth pointing out that the Fed is currently paying the same rate of interest on both required and excess reserves so a bank is getting the same IOR either way. There's just no way to spin it to say IOR is a barrier to lending. Lack of creditworthy borrowers on the other hand... that's a problem and Fed policy can't manufacture them.
IOR is just one in a suite of tools the Fed uses to maintain the overnight rate in a floor system.
So when you talk about reducing IOR, the transmission channel for that to have any economic effect is through the fed funds rate and it would take quite a leap to believe that there's an economy-lifting wave of demand for loans pent-up behind 8 basis points on the fed funds rate.
As for charging banks to hold excess reserves through negative rates, it's a tax on banks. Unless negative rates magically manufacture additional creditworthy borrowers, which they won't, then all it accomplishes is to increase banks' costs. Like any business, they're apt to respond with some combination of reduced profitability and/or passing those costs on to their existing customers. Passing them on in the form of fees and... higher rates. So you get the opposite of the intended effect, with negative rates making for tighter lending.
Hi geerrussell,
The interest on required reserves is not the same as excess reserves. Almost all of the required reserves are in the form of vault cash which pays no interest.
When banks lend, some of the excess reserves become required reserves. If the interest were lower or negative that becomes a greater incentive to loan even if it is only a tiny bit greater. Banks count every penny.
The Fed has the power to get banks to
lend more. I don't see them using that power very much. To me it looks like the purpose of QE is not to encourage more lending but to support the growth of the deposit base without lending.
Post a Comment