Exactly - “somewhat decent loans” are no longer easy to make. Banks demand higher rates or solid collateral to account for higher risks. Also, it isn’t just the bank side that determines if there are loans - individuals and businesses must be willing to borrow. They also face risk in the deal, so they want a lower-than-usual rate.
And as I said earlier, a low nominal interest rate begins to pay out as much as holding cash, which holds much less risk and is available immediately. A 0% loan makes no sense. Such things might happen in a world of government guarantees or between arms of government institutions, but bankers will not make 0% loans to the market that have any chance of not being fully repaid.
Which the Fed is paying interest upon - do the banks want 1.5% for nothing with no risk, or 3.25% with large risk? This allows the Fed to keep the banks from loaning against the reserves. As I said in my first post, it seems the Fed’s ballooning balance sheet does not represent a desire for the Fed to induce the banks to lend until the money supply is doubled, but an awkward attempt to bail out the banks’ bad loans.
Have they ever had one? The system relies upon endless inflation. It doesn’t need an exit strategy so much as a method to moderate the inflationary growth. Paying interest on excess reserves is one way. I’m sure they can figure out others.
Does the quantity theory apply to Japan? The ratio of money supply to reserves you are coming up with is based upon a regulatory requirement. So why not look at another regulatory requirement, which is currently preventing banks from making loans?
Yea - for some reason I confused myself into thinking the Fed could buy treasury bills with money created out of thin air, but not the banks. Actually they both can. And it would make sense for the banks to buy them because it should improve their CAR. The Fed would likely bail banks out if bond prices fell. And the risk of default is negligible for the foreseeable future. So the lack of risk is what allows these loans to be made at the rate they are made.
Yes, but when I say “somewhat decent loans,” I’m really just saying loans which appear safe.
Yes but the precautionary demand for money is not permanent, as soon as the economy looks like it’s recovering, the demand for cash holdings will fall, and money will flow into circulation. Essentially, you’re talking about a hyper-extended liquidity trap.
Paying interest on reserves can delay the necessary correction, but will only magnify it by a multiple of ten later on. Eventually the FED will have to pay 500%, 1000%, 1000000% interest on reserves. These schemes are bound to fail–money cannot be controlled. If inflation was as easy to control as you seem to think it is, then stagflation and the currency crises/hyper-inflation’s would never have occurred.
Japan’s inflation pales in comparison to what we’ve just done, and their capital structure was not as profoundly manipulated as ours. Appealing to Japan is simply ridiculous, as their economic situation doesn’t resemble our current situation at all. This crises is the result of inflation going back who knows when.
There’s an international dimension here. The RMB is under-valued, and the dollar is over-valued; this imbalance must be corrected. Your argument simply denies economics.
Again, I must reflect on Japan. They relied on misguided attempts by government to create their recovery, and it never came. We’re doing the same. The only method to recovery I can see is to allow the market to liquidate bad debt - we need bankruptcies. Everything else seems like it’s waiting for something else (regime uncertainty adds to this). We could say that price inflation will create higher interest rates and less cash holding. But where’s the price inflation coming from? I see stagnation.
I don’t believe the government can control (tame) inflation when it is pursuing inflationary policies, but nor do I think it can create it (at least enough to cause price inflation), given our current banking system and credit environment. If we were like China, we could easily create massive inflation. If the Fed were to resort to extremes, say by taxing reserves, rather than subsidizing them, we could create inflation.
But inflation is not the goal - not of the banks, the Fed, or the government. The interest paid on reserves is not so much about discouraging them from loaning as it is to give them free capital injections. It doesn’t work to cap inflation.
You are assuming that we will move from A → B no matter what, and that these policies will blow up in B. What if we’re stuck in A?
You’re presupposing the ceteris paribus condition, which, again, is absurd. The differences between their economy in the nineties and our economy today are monumental. Enormous aggregate savings rate, lower natural rate of interest, huge current account surplus, ect, ect.
Okay, so you’re done with the quantity theory of money, and have invented the hyper-liquidity trap. I believe that monetary growth leads to increased prices via the interest rate, and I believe that lowering the interest rate far below the equilibrium rate will create a demand for credit. Furthermore, I believe that huge international monetary asymmetry cannot go uncorrected.
They target short-term interest rates (though they’re trying to control long term rates as well) through open market purchases and sales. When they buy government securities and bonds, there’s an increase in demand, and therefore price, leading to a corresponding fall in the interest rate. The money the use to purchase the bonds are created by them–the FED writes checks against itself. The reserves are “parked” at the FED until they’re used as the base for money creation. They attempt to steepen the yield curves for “private” banks. The price of bonds, and therefore the interest rate, is entirely dependent upon FED purchases; once they stop, and begin to sell bonds (in order to drain excess liquidity), the interest rates will soar and a lot of the money will remain in the system.
I agree about Japan’s differences, but I don’t think that helps your case. Japan’s higher savings rate should have made bank lending more plentiful. On the other hand, what U.S. banks are going to want to lend to individuals and businesses already deep in debt? The account surplus and the reserve currency status are big issues and have the potential to cause massive price inflation when the trends change for the U.S. But I think that’s more long-term.
Why did Japan’s money multiplier drop?
I think you may be mis-interpreting me. I agree with the quantity theory of money, and I don’t believe in the Keynesian liquidity trap, especially as to how it relates to Japan. I believe their propping up of bad banks/loans and attempts to artificially lower interest rates were their main problem. I don’t think price deflation should be fought. If the government was literally running cash off the printing press and dumping it on the streets from Bernanke’s helicopter, there would obviously be no liquidity trap. For the lender, the “real” rate of interest is inconsequential. He’s being repaid in money, not real goods. 0% interest loans carry risk without reward. 0% interest rates can never be too high, no matter what prices are doing.
Back to the matter at hand. Saying that banks are less likely to lend in a low-interest, high-risk, politically-regulated environment doesn’t need a theory. It’s simple human action. So from a market perspective, banks have little incentive to make loans, except low-risk ones such as to the government.
From the political perspective, bad loans have just caused a crisis. Regulatory changes are coming. Regulators are scrambling to appear diligent. Pressure will be applied to rating agencies, which downgrade assets, which reduce capital adequacy ratios for banks. Thus, regulators are likely prohibiting banks from making loans due to their constantly diminishing CAR, despite adequate reserve levels. This is in addition to all the downgrades due to initial errors and the increasingly poor business environment.
It’s important to note that Japan’s central bank doesn’t primarily use official interest rates to manipulate its currency, but instead “advisory windows” for the interest rates of each member bank, if I remember correctly. It’s an odd system, but the gist is that they were able to inflate the 80s bubble without people noticing. Everyone was watching the official interest rate, but that’s not where the action is in the Japanese system. There’s a book about it online somewhere.