I’m trying to find out exactly what the Bank of England base rate is. I understood it to be the rate at which the Bank will lend money to commercial banks if they are short of reserves, analogous to the US “discount rate”. But I have been told that it is actually the rate of interest that the Bank of England pays to commercial banks for their reserves. I am looking for a clarification. I thought that central banks do not pay any interest to commercial banks for their reserves… but it seems I was wrong about that.
After a little research, it seems the ECB pays interest on reserves (at the “base deposit rate”), and since 2008 the Fed does the same thing. I don’t know how this is justified, and presumably its new money created out of thin air? Does anyone know if the Bank of England does this too, and if so, is it at the “base rate”?
Also, have I understood the following terms correctly?..
US: Fed Funds Rate, UK: LIBOR, EU: EURIBOR - the target rate for inter-bank lending, manipulated by the central bank through open market operations.
US: Discount Rate, UK: Base Rate, EU: Base Borrowing Rate - the rate charged to commercial banks for short-term loans to top up reserves (not commonly done, as banks generally turn to each other rather than the central bank).
US: Base Deposit Rate, UK: ?, EU: Base Deposit Rate - the interest paid by central banks to commercial banks for their reserve deposits.
The commercial banks pay interest to the central banks when the commercial banks borrow from the central banks. Standard loan procedure. Were you asking something else?
Also your title asks the question, “Do central banks pay interest on reserves?” As I stated in another thread, not to you, what reserves?
Sorry, let me be clearer. The commercial banks have a reserve account at the central bank - maybe 10% of their outstanding demand deposits. I am asking whether the central bank pays interest to the commercial banks on the balance of their reserve accounts.
The commercial banks get their money from the central banks and owe the central banks interest. The federal reserve “pushes the button” to get the U.S. mints to print or coin and then loan. The federal reserve provides more money to the general circulation to loan out to all other banks by the Federal Reserve buying Treasury Bonds in which the State gives as IOU’s to the Federal Reserve. IOU’s to be paid back by the State via taxes. Yet, the Federal Reserve having these Treasury Bonds gains interest just as any other consumer of Treasury Bonds and therefore the State owes the Federal Reserve more money than the Federal Reserve ever prints. That’s why they say debt is good. For the State always owes the Federal Reserve more than the Federal Reserve “prints” due to interest. I’m not sure where your coming up with what seems to be the opposite: The commercial banks “print” or “acquire” the money first and then loan it to the central banks/Federal Reserve…? That’s how I’m reading your statement which is not how this monetary system works. The pyramid scheme, as it’s been called, works the other way around. Commercial banks are given loans by the Federal Reserve and the Commercial banks can then loan out 20 times (if the ratio is 20:1 - for it changes and I’m not sure what it is now) more than the Federal Reserve loans. Then the supposed deal for the commercial banks is they will thereby gain 20 times more money back from the bank consumer than the commercial bank borrowed from the Federal Reserve, and that’s how the commercial bank makes a profit. Now you can see that there is not that much money out in circulation for the Federal Reserve printed much less money than is loaned via all commercial banks. But then again most loans are not paid back very quickly so the Federal Reserve keeps printing more money over time and thus why the dollar is devalued over time. It is a loan, debt system. That’s why they say debt is good. If all debts and loans were paid back, still even more dollars would be owed to the banks due to interest and the pyramid scheme. Also all dollars are debt notes so if all debts were paid back there wouldn’t be any dollars in circulation (and as I stated even more money would still be owned), which leads into nationalization of assets. So when I say, what reserves? I’m also saying there are no reserves. It’s all debt initially starting with the Federal Reserve buying Treasury Bonds and that’s when the dollars are initially circulated into the system. It’s literally a debt system. That’s why U.S. dollars are called fiat.
That is all understood, I am familiar with Rothbard’s work. To a commercial bank, it’s reserves are it’s deposit at the Fed. If a bank is operating at a fractional reserve ratio of 20:1, then for each $20million of demand deposits, there is $1million worth of base money in their account at the central bank.
I am talking about a new development, I think brought in by the ECB, and now since 2008 being copied by the Fed. The Fed has started paying interest (at the “base deposit rate”, currently 3.5%) to commercial banks on their reserves. That is, the Fed is paying the commercial banks $35k per $1million in their reserve account.
I will look at these links you provided. Thank you. My first inclination though, before I read the links, is how does a commercial bank gain interest on a loan it borrowed? That’s the same as me gaining interest on my mortgage or student loans. But I will look at the links you gave.
FED pays interest on excess reservers held in its account I think. The idea is to fine tune interest rate, not to allow it to fell much less than target rate. If target rate is 0,5%, FED does not want it to fell to 0,1%. It’s obviously hard to target precisely these small rates by OMO. So, if FED pays 0,25% on excess reserves, the interest rate in interbank market should not fall below it (as banks can arbitrage this 100% risk-free). It should set the floor for interest rate.
Yeah, it’s what I thought. Basically what they are saying is they loan the banks dollars, as I already stated, and now what they want to do is pay interest on these loans (the reserves are loaned dollars, it’s just that a certain percentage of these loans have to stay in the banks as a reserve, which is also called on-demand dollars. This is all just bank jargon for the bank has to hold some of the loaned money from the federal reserve so people can make withdraws on their account. The banks are just regulated to have a certain amount of money kept in their vaults.). Now they could do two things. They could raise the percentage of reserves per loan from the fed. that are to be kept. Or they could simply just pay them interest on the reserves. The interest is more flexible cause the individual banks could keep money in their vaults and gain interest as they see fit. An across the board regulation on raising the percentage of reserves (money in the vaults) that have to be kept may not meet the bank withdraw demands for some unnumbered individual banks. Actually there is a third action that could be taken, which is the federal reserve just gives more loan money out, thus buys more IOU’s and prints more money and gives it out on demand. But that is what they are doing with the interest rates. It’s just an easier mathematical calculation to show this much reserves and fed. then simply prints and gives this much money in interest. The federal reserve could just print the money and give it out to the banks when the banks come and ask for it (and not name it interest), but this always appears in the banking system to mean that that particular bank is becoming insolvent and losing its vaulted money (reserves). That can cause a bank run. So to turn it around and just call it interest on their reserves then creates a constant cash flow to the commercial banks in a way that doesn’t make those individual banks appear insolvent and losing reserves. In the banking system under a fiat and/or fractional reserve system mainly all the actions are the same. Print more money from debt IOU’s. Yet all the transaction are given different names (these names are important to ease fears) to keep the money flowing. They have to keep the money flowing and it’s tough cause under their system they never have enough money in circulation compared to the amount of loans signed out. So there is always more debt than dollars and they are always running to keep ahead of the expanding debt before the run out of dollars on demand. But as said if all loans and debts were actually paid back then no dollars would be in circulation and even more dollars would be expected to be paid to pay off the interest on those loans. It’s a debt system. Meaning the debt never disappears. That’s why they say debt is good. It’s the biggest Ponzi scheme in the whole world and the U.S. government is the instigator in the deal, but the Federal Reserve asks and co-conspires in this corrupt scheme (U.S. dollar is currently the world reserve currency). U.S. government can never pay back the Federal Reserve on those IOU’s via tax payer money. Mathematically it’s impossible unless the pay backs become nationalized assets to pay the interest on those IOU’s. And the U.S. is nationalizing institutions now, so…
The Fed manages the “federal funds rate” through open market operations (buying and selling securities, typically government bonds).
But with the current credit issues, the Fed is pumping money. Particularly, the FED has come up with all kinds of new lending programs (Commercial Paper Funding Facility LLC (CPFF), Term Auction Facility (TAF), etc) to allow it to buy all kinds of securities as it sees fit to provide liquidity to the fincial sector (i.e. print money and give it to insolvent investmanet Banks and Insurers and other huge fincial corporations).
But if the FED pumps money into the markets, it their open market operations are decidely one sided and they drive the federal funds rate down to 0. The Fed can not conduct and does not want to conduct sterilization actiosn to offset pumping (i.e. like selling treasuries) because it wants to pump money.
So with pumping, the fed funds rate goes to 0 - Why would a bank borrow money at any spread when the FED is giving away money for free?
In paying interest, a rough flor for the federal funds rate is set. The Federal funds rate effectively trades marginally below this interest rate because some of the banks being flooded with liquidity (e.g. GSEs like the Federal Home Loan Bank) can’t earn interest on excess reserves at the FED so they sell the excess reserves to banks at just under the interest paid to the banks on on excess reserves. This is the risk-free arbitrage profit for private banks that provides even more incentive for banks to park excess reserves at the Fed.
One consequence of a 0 fedral funds rate is the fees on some money market funds will exceed their yield. But there is a bigger goal.
More importantly, in paying interest on reserves, Bernanke thinks he can hold off inflation because he is incentiving banks to keep any new money as reserves. Bernanke thinks he can print money to “buy bad assets from banks” or to “loan funds to banks and take bad assets as security” (i.e the new “lending programs”). The goal being to improve Bank’s balance sheets to prevent a collapse. But since money printing can be inflationary, by paying interest, Bernanke thinks he can minimize some of the inflation by encouraging banks to not lend these new reserves, as there are still landmines and major risk everywhere, so even .25% interets looks great in a deflating environment.
When things get better Bernanke plans to sell the bad assets back/call in the loans and return the security, and then after he “mops up this newly printed money”, he will stop paying interest and incentive the banks to loan again.
Obviously the ability to “mop this up” is IMO and in any Austrians view a pollyanna ending but that is a theory behind paying interest on reseves. It started last fall.
The official theory what caused the crisis is of coruse “sudden change of people preference to hold cash”. So, Ben thinks, if he can pour enough cash, flush the markets with liquidity, everything will revert to the state before the crisis. Unfortunately for him, you may rollback, hower you can rollback to exact moment that caused the problems and that is inflationary times in mid 2008.