The Fed Is Saying One Thing But Doing Something Very Different

George Washington's picture

Washington’s Blog

increase lending, reduce unemployment, and stimulate the economy.


For example, as I reported

money is circulating through the system]





(Click for full image)





(Click for full image)


Why are banks building up their excess reserves?


As the Fed notes:

Federal Reserve Banks pay interest on required reserve
balances--balances held at Reserve Banks to satisfy reserve


the financial crisis, required reserves were about $40 billion and
excess reserves were roughly $1.5 billion. Excess reserves spiked to
pre-crisis levels and remained there until the middle of September
2008. Following the collapse of Lehman Brothers, however, total
over this period, this change was dwarfed by the large and
unprecedented rise in excess reserves.

[Figure 1 is here]

tell us about current economic conditions and about bank lending
behavior? Some observers claim that the large increase in excess
reserves implies that many of the policies introduced by the Federal
Reserve in response to the financial crisis have been ineffective.
banks and other intermediaries by the Federal Reserve since September
banks are choosing to hold so many reserves instead of lending them
is crucial for resolving the credit crisis.

This view has lead
to proposals aimed at discouraging banks from holding excess reserves,
people hoarding money during times of financial stress and mentions
proposals that were made to tax money holdings in order to encourage
lending. He relates these historical episodes to the current situation
[this historical] concern about cash hoarding suddenly seems very

banking system is determined almost entirely by the actions of the

liquidity facilities introduced by the Federal Reserve in response to
bank lending behavior may lead to small changes in the level of
reflects the size of the Federal Reserve’s policy initiatives, but says
little or nothing about their effects on bank lending or on the
economy more broadly.


Why Is The Fed Locking Up Excess Reserves?

Why is the Fed locking up excess reserves?


sufficient to bring reserves down to the desired level.

Kohn said in a speech on January 3, 2010:

interest rates even with an extraordinarily large volume of reserves in
interest rates.


Reserve System. To restrict excessive flow of reserves back into the
reserves. Doing so would not only discourage banks from draining their
reserve holdings, but would also exert upward pressure on broader
market interest rates, since only rates higher than the overnight
reserves is supported by economic theory as a means of reducing


also discussed the importance of paying interest on reserves when the
level of excess reserves is unusually high, as the Federal Reserve
central bank to maintain its influence over market interest rates
independent of the quantity of reserves created by its liquidity
be determined by conditions in the financial sector, while setting its
target for the short-term interest rate based on macroeconomic
conditions. This ability to separate monetary policy from the quantity
of bank reserves is particularly important during the recovery from a
financial crisis. If inflationary pressures begin to appear while the
interest-on-reserves policy to raise interest rates without necessarily
removing all of the reserves created by the facilities.

As the NY Fed explains in more detail:

central bank paid interest on reserves to prevent the increase in
reserves from driving market interest rates below the level it deemed
appropriate given macroeconomic conditions. In such a situation, the
absence of a money-multiplier effect should be neither surprising nor

Is the large quantity of reserves inflationary?

observers have expressed concern that the large quantity of reserves
will lead to an increase in the inflation rate unless the Federal
recover, these reserves can be converted into new loans and faster
money growth” that will eventually prove inflationary. Under a
traditional operational framework, where the central bank influences
interest rates and the level of economic activity by changing the
the Federal Reserve is paying interest on reserves, however, matters
are different.

When the economy begins to recover, firms will
have more profitable opportunities to invest, increasing their demands
opportunities that are profitable at the current level of interest
level of economic activity will increase. Left unchecked, this growth
in lending and economic activity may generate inflationary pressures.
Under a traditional operating framework, where no interest is paid on
reserves, the central bank must remove nearly all of the excess
by removing these excess reserves can the central bank limit banks’
willingness to lend to firms and households and cause short-term
interest rates to rise.

Paying interest on reserves breaks this
increase market interest rates and slow the growth of bank lending and
economic activity without changing the quantity of reserves. In other
reserves. By choosing this path appropriately, the central bank can
guard against inflationary pressures even if financial conditions lead
it to maintain a high level of excess reserves.

This logic
applies equally well when financial conditions are normal. A central
times because doing so offers some important advantages, particularly
central bank for payments purposes. They also tend to send payments
significant operational disruption or of gridlock in the payments
the interest rate it pays on reserves to influence market interest

Because financial conditions are not "normal", it
appears that preventing inflation seems to be the Fed's overriding
purpose in creating conditions ensuring high levels of excess reserves.

As Barron's notes:

multiplier's decline "corresponds so exactly to the expansion of the


It's not just the Fed. The NY Fed report notes:

Most central banks now pay interest on reserves.

Financial Services Committee for eleven years, assisting with oversight
of the Federal Reserve, and subsequently Professor of Public Affairs at
paid on reserves so as to stimulate the economy.

Last week, Auerbach wrote:

taxpayers to the banks which currently hold over 50 percent of the
increase these interest payments to prevent the huge amount of bank
reserves from flooding the economy. They should follow a different
policy that benefits taxpayers and increases the incentive of banks to
make business loans as I have previously suggested.

In September, Auerbach explained:

Immediately after the recession took a dramatic dive in
September 2008, the Bernanke Fed implemented a policy that continues to
further damage the incentive for banks to lend to businesses. On
announced it would begin paying interest on the reserve balances of


these reserves in 2009.


A number of people spoke
about the disincentive for bank lending embedded in this policy
including Chairman Bernanke.




Jim McTague, Washington Editor of Barrons,
University of Texas Professor Robert Auerbach an economist who studied
malpractice suit against Federal Reserve Chairman Ben Bernanke, as the
Fed, stop paying, he says."


Shortly after this article appeared
Fed Chairman Bernanke explained: "Because banks should be unwilling to
reserves did impair bank lending. Bernanke's rationale for interest
payments on reserves included preventing banks from lending at lower


be the bank's perception of its best investment opportunity."


Why does Chairman Bernanke, who has studied the Great Depression of
actions by the Fed on bank reserves described by Milton Friedman and
Anna Schwartz, repeat the mistaken policy?

As the
to May 1937 they doubled the reserve requirements for the large banks
(7 percent to 14 percent of checkable deposits).


2008 to 2010 policy also immobilizes the banking system's reserves
reducing the banks' incentive to make loans.


This is a bad policy even if the banks approve. The
correct policy now should be to slowly reduce the interest paid on
bank reserves to zero and simultaneously maintain a moderate increase
in the money supply by slowly raising the short term market interest
rate targeted by the Fed.
Keeping the short term target
reserves so they can receive billions in interest from the taxpayers

The fact that the Fed is suppressing lending
shows that the Fed is saying one thing and doing something else


And see this.


Comment viewing options

ATG's picture

First they came for the banks and we did not do anything

Then they came for the media and we did not do anything

Then they came for the politics and taxes and we did not do anything

Then they came for the guns and we did not do anything

Then they came for privacy and we did not do anything

Then they came for business and jobs and we did not do anything

Then they came for the pensions and we did not do anything

Then they came for medical care and vaccinations and we did not do anything

Then they came for the air, food and water and we did not do anything because we were starving and sick

Never too late to declare independence 5:43

Bob Sponge's picture

This article is an excellent compilation exposing the Fed. I wonder if Benny may be working to cook a crisis (China included) which helps the Fed and other central banks in the cartel make the case that a one-world currency is the way to solve world economic problems. I recently read a quote (I think in one of Bruce's articles) where Benny was basically supporting a one-world currency. I'm sure the banking cartel would love a one-world currency.

Mitchman's picture

Bernanke:  Working one day at a time to be remembered as the worst central banker in history.

gkm's picture






Orly's picture

Thanks for that very clear analysis.

DavidRicardo's picture



This confounds you, but it shouldn't.  The big, dark, dirty secret is that if the Fed did exactly what you say, THERE STILL WOULDN"T BE ANY DEMAND FOR LOANS.


For the sake of confidence (in order to facilitate further looting), it is much better to maintain the Fed's image as "stingy" and as overcautiously restraining "animal spirits" and entrepreneurship.


Also, power is playing a waiting game here.  Power goes to power.  Part of what is occurring is cartelization, so you want to drive every smaller business OUT of business.  So you wind up with a sort of Franco-ist economy.

gs_runsthiscountry's picture

"Also, power is playing a waiting game here.  Power goes to power.  Part of what is occurring is cartelization, so you want to drive every smaller business OUT of business.  So you wind up with a sort of Franco-ist economy." hit the nail on the head.

If anyone wants evidence of this, take a hard look at what has been going on in Natural Gas industry. Indeed, it is a case study of your above statment.

DavidRicardo's picture

It's called Mellonesque liquidation.  I've been talking about it for 3 years, but no one is listening.  And that's just fine--as long as you understand WHY they're not listening.


Reason they're not listening: BLS unemployment Bachelor's level or above--4.7%.


When will they listen?


BLS unemployment Bachelor's level of above--20%.

bubba1231's picture

GW has posted articles stating that OBL was nor responsible for 9/11.  Until GW apologizes for taking a giant crap on the face of every 9/11 family member he should be banned from this site.

High Plains Drifter's picture

Have you ever noticed how OBL never seems to either be caught or killed? Do you think that such a man even exist?  Just because a 911 family member still buys into that bs. does not mean it is true. They have to wake up just like everybody else.

Uncle Remus's picture

And you can speak for that group because?

Shameful's picture

Hmm you know the family members of those killed have their questions about it right?  So in effect are those family members taking a dump on their own faces?

hugolp's picture

Why would the Fed wanted to do all those things?

What the Fed really wants to do is save the banking system and help the government finance the debt. That's all. And then it lies about how more money printing is going to help the economy, create jobs and all the mambo jambo.

Steroid's picture

Bill Gross and his ilk will milk them with their MBS holdings after the title collapse. Or

Obama will be the white knight against the evil banks and the people will start the first US socialist "revolution". Money will go out of fashion and we all be promised to use golden urinals.

I would love to see the third option of a reboot of the Republic but people are too busy watching TV.

Gordon_Gekko's picture

This shows beyond any doubt whatsoever the truth about the Fed - A RUTHLESS CRIMINAL BANKING CARTEL owned and operated by world oligarchs.

High Plains Drifter's picture

karl Douchinger is looking for you. He has a ax to grind. Something about doorstops and paper weights.

Shameful's picture

Isn't it a crazy world?  Even the price of "doorstops" is going up :)

Shameful's picture

Hey Gordon, any chance we get another article with your current take on the situation with the PMs and the looming 'good times'?  If I'm seeing the numbers for delivery right,  they look like dynamite.

drbill's picture

Anyone that reads zero hedge knows this. The real question is how do we effectively spread the news so that everyone knows this?

kalum's picture

Let's hear it for the Banks!!

moneymutt's picture

very interesting, it is always important to watch what politicians do, pay no attention to what they say.

Once again, they make it appear everything they are doing is to help Americans, when in fact, American people are just used as a ruse for them to further fleece American people. Bank bailouts, HAMP, Fred/Fan, low mortgage rates etc...these are supposedly done for us, in particular, for poor homeowners, while in fact none of this helps us much, and harms us via our tax dollars being taken for things of no benefit to us..all of it helps the banks make profits.

Buttcathead's picture

Banksters are building up their excess reserves becuz, as the inflation boogie man leaves town he will lanch a 44 trillion mega-ton deflation bomb at the last of the dip shit buyers. shock and awe baby !

zhandax's picture

Back when the fed announced it would begin paying interest on reserves I wrote that BB had crafted a rheostat for the money multiplier.  Maybe I should have called it a volume control because best I recall, there wasn't a single response to that post.  Regardless, that is exactly what transpired; the fed can now dial the multiplier up or down at will since adopting this policy and they have had it set to minimum from inception.

They created this control system, they can see it works, and they have never tried turning up the volume, so clearly their stated purpose for QE2 is bogus, a sham, a fraud.  Since they have a mechanism for manipulating the money supply domestically that they are not using, QE2 is clearly targeting international concerns.

This simply supports the theory that QE2 is an attempt to adjust trade imbalances by forcing forex cross levels to desired targets, i.e. inflate the Renembi against all currencies.  Once again the only benefit I can see from inflating the Renembi is that China is currently the only large economy with the capacity to soak up large marginal increases in debt.  The multiplication of debt is required to keep the fiat ponzi alive and China is simply the only target who is not already saturated.  I don't think they are packing up the Eccles building for a move to Beijing; banksters live by increasing the overall debt levels and here is a huge 'under-serviced client'.

Orly's picture

Thanks for that very interesting thought.  I have had the same sort of idea myself ever since I have heard about QE2.  My thought was that it would be used to put an air-brake under the Euro, the Ozzie Dollar and (perhaps most of all...) the Pound Sterling.  The Euro and the AUD were at astronomical highs comparing where they came from.  They want to keep the currency distortion to a minimum.

How would all of these things happen to affect a rise in the renminbi across all currencies?  If it is possible for the AUD to fall against the USD and the GBP, in danger since the crisis began, at the top of a long formation, then wouldn't the results they are trying to achieve necesssarily come through some sort of USD manipulation vis-a-vis the Chinese currency?  How would that work exactly?

Thanks again.


gkm's picture

You Sir go to the head of the class.  Well done.

Eric Cartman's picture

I'll kick Ben Bernanke in the nuts! 

Azannoth's picture

I just discovered something, after seeing that Ben Bernanke's 2nd name is Shalom(wtf?) I googled if he is jewish (yes he is) than I googled Alan Greenspan (jew too), than Paul Volker (from jewish family), .. wtf? Aparently all FED chairmen ever where all jews (now if this is not a consipracy than nothing is), don't believe me google it

Paul E. Math's picture

I believe that at least the 2nd Fed chairman, Harding, was not Jewish.  There are probably others but I can't be bothered to check further since it really doesn't matter.

The Fed should not exist.  The religion of its leaders is irrelevant.

Sort of like the democrat v. republican debate - it doesn't matter because both parties are corrupted by the influence of monied interests.

Same thing with the Fed.  It's the institution itself that is corrupt, as are its economic and philosophical underpinnings.

So let's not waste our time with this religious crap.

Uncle Remus's picture

The religion of its leaders is irrelevant.




So let's not waste our time with this religious crap.

Clearly, you're not paying attention. Religion, money and oil - they are singly or collectively at the root of every single thing that happens in the world today.

dnarby's picture

You pay attention. 

Religion is just one thing TPTB use to herd the morts to gain control over money and oil.

FatFingered's picture

Welcome to the USA.  Now go check out Hollywood, the owners all five media networks, the owners of all the big financial institutions, the Bush Regime, the music industry, and of course, all of the stars of all of your old favorite TV shows.

I am not being nasty here.  I have some Ashki blood myself.  I am just sayin...


kaiserhoff's picture

I don't think Mr. Ed was Jewish, but the rest of them, pretty much.  The truth, stated simply and without malice, cures many problems.

While we are on the subject, what's with all of these Canadians on ZH posing as white bread Americans?  Shouldn't we notify homeland security?.....oh, I forgot.....big brother is already watching.

High Plains Drifter's picture

Well duh?  You just noticed huh?  I am out of here. Got to get my Starbucks Sunday morning wake up drink.

Cognitive Dissonance's picture

What ever you do, please leave them intact so we can string him up by them.

High Plains Drifter's picture

I saw old sickly skinny Dick Cheney on CSPAN yesterday, speaking about what a great President George Bush was. I don't care how sick he is. I think it would be a real trip to see that piece of trash dangling at the end of a rope. Sure he will soon go meet his maker. For that, there is no doubt and the Book of Life will be opened at his case decided for eternity. But in this life, it would be delicious to get some justice for the amount of damage these traitors have done to this country.

Shameful's picture

Isn't he already the undead?  Hearing rumors about how the man has no pulse and he is remarkably cool with that.  Guess people can really joke about him having no heart :)