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| Graph #1: The Ratio of Required Reserves to Total Reserves |
(The shutdown occurs between August and November of 2008.)
I was shocked when I first saw that graph -- as I hope you are. But when I caught my breath I realized what it shows is a change in policy. It doesn't show that the whole economy changed in an instant. It only shows the impact of a single policy decision.
Or so I think. If you look at economic data (Industrial Production, for example) you see a more gradual change. Graph #2:
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| Graph #2: The Ratio from Graph #1 (blue) and the Industrial Production Index (red), 2002-2014 |
4 comments:
I don't get why you think the change in total reserves reflects a change in policy.
The only real function of the federal reserve in its 100 years of existence has been to ensure the proper functioning of the US dollar payment system.
The reason for the increase in total reserves starting sept.2008 was the same as the
reason for the increase in sept.2001. There was a threat of a systemic run on banking and it was the Fed's job to keep that from happening.
In the days after Lehman collapsed there was a run on institutional money market funds.
http://www.bogleheads.org/w/images/1/10/Moneyfundcharts.gif
Had the run been allowed to continue the US dollar payment system would have ground to a halt. In all likelihood that means you would have difficulty in getting anyone to accept your checks or credit cards and businesses would have failed to meet payroll obligations and who knows what would have followed had that been allowed to continue.
Since 1934 it has been Fed policy to not let that happen so its a bit baffling that you regard it
as a change in policy in 2008.
So you are saying it was not a change in policy, but rather a change in circumstances, which required a different response from the Fed in order to satisfy an unchanged policy concept?
Yes, I'm saying the response of increasing excess reserves to keep the payment system from becoming dysfunctional has been done before. The anticipated threat to the payment system in Sept 2001 never materialized, but in the fall of 2008 it did.
Another example of bank excess reserves increasing in response to anticipated breakdown in the payment system was the rollover of the calender from 1999 to 2000. It was unknown to what extent the computer software would fail due to the date change. In both 2000 and 2001 it turned out to be a false alarm and the transactions that created the excess reserves were quickly reversed.
Late to the thread but oh well, better to leave this here than having it rattle around in my head :)
jim said...
The reason for the increase in total reserves starting sept.2008 was the same as the reason for the increase in sept.2001.
This is correct. The reason being a fed decision to increase excess reserves in response to a crisis. However...
Art said...
. But when I caught my breath I realized what it shows is a change in policy. It doesn't show that the whole economy changed in an instant. It only shows the impact of a single policy decision.
This is the more complete and accurate statement. It shows regime change in fed policy. That's the difference between 2001 and 2008.
In 2001 the fed quickly drained the excess reserves back out of the system when the immediate crisis passed. They did this because their policy regime depended on keeping excess at zero in order to prevent drift away from their policy rate. We had a crisis, a spike in excess as policy in response but no change in the policy regime used by the fed for rate maintenance.
In 2008, we had a spike in excess reserves in response to a crisis but instead of draining that excess in service of the existing rate maintenance regime, we saw regime change to a floor system where the fed could maintain its policy rate in the presence of excess reserve. Hence the permanent drop seen in that chart.
A tactic succinctly explained in a few bullet points on page 1 here in this article from the new york fed:
Divorcing Money from Monetary Policy
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