Reserves are really potential inflation. Without velocity they do nothing more than repair insolvent bank balance sheets. If the Fed decreases interest on reserves in an attempt to ignite lending, it will signal the beginning of the end and will create the beginning of the stampede into real assets and commodities. If you were a bank would you lend to an impaired entity that will likely never pay you back or would you buy an real asset in order to attain your yield through capital appreciation?
So the chain of causation looks like this: banks sell their toxic debt to the Fed for fresh reserves, then the banks utilize reserves to buy up gold and commodities. This in turn allows more deflationary pressure to build in their debt positions, which are then dumped onto the Fed for more reserves. End result, all debt finds its way to the Fed balance sheet and everyone’s debt comes home to roost in the form of base money on your front lawn. Hyperinflation.
23 JULY 2012
About Those Excess Reserves At the Fed
But then we see pieces in the financial press or on econo-chatboards like this, scornfully dismissing the notion that interest payments on excess reserves matter at all because the excess reserves don’t matter. Base Money Confusion by Izabella Kaminska.
I have even seen the Fed arguing out of both sides of their mouth on this one. I know there is room for disagreement, but that is just a bit too much.
I suspect that some economists argue that Fed interest payments on reserve do not matter because they do not want to deal with the political issue of paying what is essentially a subsidy to the banks for the reserves that the Fed creates for them.
And there are plenty of economists who seem to make whatever argument that the Banks want them to make on any issue on any given day. It seems to be almost a cottage industry at some university economics departments.
Or in some cases it could be that like most money misconceptions, some folks like to get caught up in the details of the thing, putting an inappropriate linear bustier on a dynamic system process, and thereby become mesmerized by ‘chicken and egg questions,’ losing sight of the big picture but ‘proving’ some outlandish theory about how money is created and how the banking system really works.
If reserves do not matter, if they are a meaningless accounting entity, then it would not matter what the Fed pays on them, except for the purposes of a risk free handout to their banking buddies. And there may be a valuable insight in that after all.
Regardless, I would just like the Fed to make up its collective mind what their position on this really is, and not make up whatever argument they feel suits the moment, although that does seem to be à la mode amongst economists these days. They have become as bad as attorneys and accountants. The truth is whatever we say it is, whatever the guy with the most money wants it to be.
This might be a fine question for some astute Congressperson to pin Benny down on for the record the next time he stops by for a chat. I seem to recall the NY Fed dissing a Congressperson on this matter a few years ago when they suggested that paying interest on Bank Reserves was inhibiting the flow of money out of the banking system and into the real economy.
So the next time I get into a discussion on this with some condescending obscurantist from the NY Fed, I am just going to send them this link and let them have at it with Ben, Alan, John and the other Sorcerer’s Apprentices.
08:12 Former Fed Vice Chairman Blinder says Fed should cut IOER -WSJ
Former Fed Vice Chairman Alan Blinder, in an opinion piece, said the Federal Reserve has many weapons left to provide a boost to the economy, but the most powerful tool would be lowering the interest rate on excess reserves (IOER) held by banks.
Blinder said Operation Twist, QE3, and forward guidance are weak weapons that won’t be as effective as cutting the IOER to zero, and if nothing goes wrong, to -25bp.
He argues that doing such would provide a powerful incentive for banks to put some of their idle reserves to work, possibly lending it out or putting it in the capital markets.
Fed Chairman Ben Bernanke said last week that the Fed still has a number of tools available should it decide to implement additional stimulus, including its balance sheet, communications strategy, IOER and the discount window.
The Matrix Sentry 
